You might hear the words ‘assets’ and ‘liabilities’ often when running your own business, but what do they mean and why are they important? This article will look at what liabilities are in business by examining the following areas:
- What are liabilities in business?
- Examples of liabilities
- Why identifying your business liabilities is important
- Other definitions of liabilities in business
What are liabilities in business?
Simply put, liabilities in business finance are funds that you owe. This could be any money that you owe to other people, banks or businesses. It can be a real cost, like bills or contracts you have to pay, but also a potential cost, such as a possible legal dispute that you have to budget for.
The reverse of a liability is an asset. Assets are the valuable resources your business owns. Quite often you’ll see both together on reports designed to understand the full financial situation of the business, to see your debts and the value of what you own.
Think of your assets as money going into your pocket and liabilities as the items that take it out of your hands. Liabilities (and assets) can fall into one of two categories – current and long-term.
Types of liabilities
Current liabilities are debts that you plan to have paid within a year.
Long-term liabilities are money that you will pay back over a period of longer than 12 months.
For example, a business may take a mortgage out on their premises and the repayment period could be over 20 years. The value of the mortgage is counted as a long-term liability for the business. However, the monthly repayments you make over a year are considered current liabilities as it is the current portion of the debt you are paying back. These payments are recorded as short term debts because you will have to consider them in your operating budgets month to month.
Examples of liabilities
Let’s look at some examples of liabilities. Whether these are long term or current will depend on your business and when you are required to pay back the money you owe for things like:
- A business loan
- A mortgage on a business property
- A rent payment on a business premises
- Any other bank debt, such as overdrafts or charges on an account
- Supplier contracts you owe
- Other accounts payable entries, such as invoices for contractors’ work
- Other financial obligations, such as paying wages or freelancers
- Taxes due to be paid to HMRC
- Utility bills and insurance monthly payments
Why identifying your business liabilities is important
It’s important to understand all the debts your company holds for a variety of reasons.
First of all, for your financial reporting. With effective and reliable reports, you are able to make decisions about the operation of your business and its ability to afford changes. If you are looking to grow your business but don’t take into consideration your monthly liabilities then your operating costs and cash flow will be affected. This would effectively stall the growth plans you had, so it’s important to be fully clued up.
You’ll require your liabilities total for a variety of reports, for example:
- Your balance sheet will require a total of liabilities.
- Profit and loss statements may need monthly liability payments, such as supplier bills or loan payments.
- Net assets calculations. These show what your assets are worth once paying off any debts.
- Equity value shows how much your share of the business is. You need to know your total assets and total liabilities to understand what the value of the business is.
- Cash flow ratios will help you with your available cash flow, based on paying your other financial obligations.
Ultimately, the total of your liabilities shows how much debt you have. The more you monitor how the total grows or reduces, the better understanding you have for making plans and decisions for your business.
Liabilities can also make transactions between businesses more efficient. Using accounts payable for liabilities payments can sometimes benefit your cash flow, like if you need to pay a supplier, but want to do so when it suits you.
For example, if you run a cafe you might have a supplier bring your cold drinks to the premises every two weeks. They deliver a couple of crates of bottles and canned beverages, and you pay them within the month, instead of on delivery. This allows you to pay the drinks company at a moment which will not impact your cash flow, and they are also able to make more deliveries without being disrupted by taking payment.
In this example, you count the total of your invoice as a liability (in your accounts payable) because you are due the money in the short term in return for the products. The drinks supplier, in turn, counts your invoice as an asset (in their accounts receivable) because they are legally owed the money.
Other definitions of liabilities in business
Liability can also refer to legal responsibilities in business. This could be responsibility for taxes or for individuals, such as employees or the public. In legal terms, a liability means a risk, and many businesses have different types of liability insurance to protect themselves from any legal claims made against them. You can read more about public liability insurance here, if this is relevant for your businesses legal responsibilities.
Save time on financial management
It’s easy to manage all your financial data in one place with the Countingup business current account. The app comes with free built-in accounting software that automates the time-consuming aspects of bookkeeping and taxes. You can view real-time insights into your business’ finances, profit and loss statements and tax estimates, and you’ll be able to create and send invoices in seconds.
You can also share your bookkeeping with your accountant instantly without worrying about duplication errors, data lags or inaccuracies. Seamless, simple and straightforward!
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