In accounting, liabilities refer to the value of money plus any other items that your company owes to another firm or individual.
In simple terms, liabilities are your debts, both that are due in a week or years. These could be a short-term loan, unsettled invoices & bills, unpaid salaries, fines from lawsuits against your business, etc.
However, you can’t classify your assets under liabilities. While the former is money that some entity firm or individual owes your enterprise (e.g., accounts receivables), liabilities refer to the things your business owes people.
If you subtract the sum of your firm’s liabilities from its assets, you remain with the shareholder equity.
What is the role of liabilities in business?
Liabilities are important to your accounting processes for various reasons. Below are some reasons to keep an eye on your liabilities:
- They stand for the claims that other firms, individuals, and authorities have against your business assets. Liabilities help you calculate your shareholder’s equity, which represents your brand’s net worth.
- Liabilities help you sustain your business functions. As a business continues, its owners take out debt to purchase assets or inventory, finance growth opportunities, or clear an overhead when sales are slow.
Lastly, they have an actual impact on a business’s standing. Most liabilities have some kind of carrying cost or cash that must be billed regularly as interest payments. When deducted, along with other liabilities, you get a firm’s net profit.
Types of Liabilities
Though liabilities can be any money or financial commitments owned to others, all of them fall into one of these two categories:
- Short-term liabilities: Short-term liabilities are those that your firm must settle within the year. They may include small loans, taxes, salaries, and uncleared invoices.
- Longterm liabilities: These are debts that you need to pay in the long-term, any time beyond 12 months such as business term loans, worker compensation, credit lines, and pension liabilities.
A company can incur liabilities in multiple ways, and each has an impact on a business’s finances.
To stay ahead of your liabilities, hire an accountant and use legitimate accounting software to simplify their work. These tools help you keep track of all your finances and give a clear picture of your liabilities vs assets.
Michael Hollis is a Detroit native who has helped hundreds of business owners with their short-term loan solutions. He’s experimented with various occupations: computer programming, dog-training, accounting… But his favorite is the one he’s now doing — providing business funding for hard-working business owners across the country.