In their original meaning, Liabilities refer to several obligations, in terms of services or monetary compensation, that an entity owes to others. It refers to something that is to be lost by the possessor. In terms of accounting,
it refers to a company’s financial obligations that it owes to its investors, business partners, suppliers, and employees in terms of wages, among many others. These liabilities in accounting are found on a balance sheet, which is generated either manually, or with the help of accounting software. Most liabilities in accounting are often referred to as account payables as well.
All businesses must have liabilities, except those that function only on cash. Let us delve deeper into this topic and understand what Liabilities refer to in the domain of accounting.
- Some liabilities in accounting relevant to small businesses
- What is the importance of liabilities in accounting for businesses functioning on a smaller scale?
- How do liabilities in accounting fare against expenses?
- Examples of liabilities in accounting
- Different types of Liabilities in accounting
- Different Categories of Liabilities in accounting
- What are Liabilities available on a Balance Sheet?
Some liabilities in accounting relevant to small businesses
If you choose to borrow money rather than pay for the services utilized by a company, as a business, you have liabilities. In addition to this, if you pay off your bills with your credit card and pay them off after a month, it is also considered borrowing.
Furthermore, business loans, mortgages, and other entries that need to be paid for in the future are counted as liabilities in the accounting domain.
Moreover, the money owed by companies to their employees in the form of wages or benefits and the sales tax collected from the clients, which are to be sent to the government, are all included in the list of liabilities for businesses.
What is the importance of liabilities in accounting for businesses functioning on a smaller scale?
Liabilities in accounting are usually painted in a bad light. However, it is to be kept in mind that several liabilities favor the company taking it. For example, we can account for some loans that need to be taken to purchase new important assets for businesses to function.
These assets can include tools, vehicles, and other important resources that facilitate or enhance a business. However, the company must keep its liabilities in check, as too many of them can act detrimental to the small business’s finances.
Owners are supposed to keep an accurate record of the debt-to-equity ratio and debt-to-asset ratio to keep their finances sorted. When explained in Layman’s language, a company needs to possess enough assets to pay off all its debts.
How do liabilities in accounting fare against expenses?
We refer to liabilities in accounting mostly as the money owed to banks or investors required to buy new assets. Examples include loans taken to buy new office equipment. Expenses and liabilities often find themselves entangled in terms.
An example would include classifying a business cell phone bill paid off monthly as an expense. However, if canceling the subscription requires a cancellation fee, the fee would be referred to as a liability. Utilities required to run a store successfully would be referred to as an expense.
However, the mortgage that needs to be paid off for your store is a liability. You would not find expenses listed on a balance sheet, though. They are included in an income statement, which are crucial financial statements. ProfitBooks can help you create accurate financial statements, which in turn can expose several liabilities, which would otherwise be overlooked.
Examples of liabilities in accounting
Let us consider some examples of liabilities in accounting to get a deeper understanding of small businesses.
- Suppose a carpenter is furnishing a kitchen, and to do that, the carpenter must pick up kitchen cabinet doors. Owing to the good relationship that the carpenter shares with the supplier, he can pick up the kitchen cabinet doors without paying. However, an invoice is raised against the carpenter, which must be resolved within 30 days. The amount owed by the carpenter on these doors is referred to as a liability for the carpenters.
- Another example would be when a freelance social media marketer is supposed to collect sales tax from all her clients on every invoice she raises. If the sales tax money is sitting in her account, it is counted as a liability, as it must be paid off to the state before the end of the month.
- Let us take another example of a business that pays its wages weekly to its employees. Suppose the company owes $1000 for its wages to be paid off within the next three days. The wages owed to the employees are referred to as a liability.
Different types of Liabilities in accounting
There are mainly two major types of liabilities in accounting which are long-term and short-term liabilities. Let us learn about long-term liabilities and short-term liabilities.
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Long-term liabilities
A company’s financial responsibilities that need to be taken care of over more than a year are labeled as long-term liabilities. Long-term liabilities include payables such as business loans and mortgages. Oftentimes, short-term liabilities are also counted in long-term liabilities when they are carried on to the next year. Thus, any liability, which is bound to be paid off in more than a year, is regarded as a long-term liability.
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Short-term liabilities
Short-term liabilities refer to a company’s financial responsibilities that need to be paid off within a year. Some common examples of short-term liabilities include Sales tax, Payroll tax, and loans and mortgages paid off every month.
Different Categories of Liabilities in accounting
Two categories available on the balance sheet are often found to be dedicated to liabilities, including:
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Long-Term Liabilities
A financial obligation that requires more than a year to pay off can be regarded as a long-term liability in accounting. They include business loans and mortgages. Additionally, the deferred short-term liabilities are also included in this category.
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Current Liabilities
Current liabilities are also referred to as short-term liabilities and are due to be paid off within a year. Some examples of current liabilities in accounting include payable interests, wages and salaries owed to employees, and amounts due to be paid to suppliers. In many cases, several liabilities are included in both categories.
To explain how that happens, let us take an example of a loan that would require two years to pay off. The loan amount to be paid off within a year is referred to as a current liability in accounting. In contrast, the rest of the amount to be paid in the second year is categorized as a Long-term liability in accounting.
What are Liabilities available on a Balance Sheet?
One out of the three available accounting categories mentioned in a balance sheet is called Liability. A balance sheet is an accounting document capable of maintaining a stern record of the assets, equities, and liabilities in accounting.
Assets refer to anything owned by a company that holds financial value. In a balance sheet, all liabilities are divided into two categories, as mentioned earlier: Long-term and short-term liabilities.
All the assets and liabilities must be recorded correctly to effectively list all current and long-term liabilities on a balance sheet. This is where ProfitBooks comes into the picture.
ProfitBooks can create accurate and in detail balance sheets that can provide information regarding different liabilities in accounting. If you handle the accounting responsibilities for your company, you can automate most accounting processes with the help of ProfitBooks.
You can leave all the manual financial data entry and management processes to ProfitBooks, and focus on more important aspects of the business.
Find out how you can leverage ProfitBooks in your business, and enhance your business procedures with the help of ProfitBooks, by creating your account for free today.
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- What are Assets and Liabilities?
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