Business Obligation – As a business owner, you probably already have some liabilities related to your business. A liability is anything your business owes or owes money to in the future, and it is used in essential proportions to determine the financial health of your business. Read on to find out what liabilities, assets, and expenses are and how they differ, as well as some examples of typical small business liabilities.
What Are Small Business Liabilities and Assets?
In the world of accounting, assets, liabilities, and equity are the three broad categories of a company’s balance sheet. Assets and liabilities are used to assess the financial condition of the business and to show the company’s equity by subtracting the liabilities of the business from the assets of the business. For these reasons, it is vital to have a good understanding of what corporate responsibilities are and how they work.
What are the liabilities?
Liabilities include everything a company owes, now and in the future. These can be loans, legal debts, or other liabilities that arise in connection with business operations, and they are often used to fund business operations or to pay for things like extensions or new equipment.
Liabilities are usually found on the right side of a balance sheet. Most businesses have liabilities unless they only accept cash payments and pay cash as well. There are three main types of liabilities:
- Short-term debt: These must be repaid within a year and include lines of credit, loans, salaries and creditors.
- Long-Term Liabilities: These take more than a year to pay off and have items like mortgages or bonds.
- Contingent liabilities: these are liabilities that depend on the outcome of a future event, such as a lawsuit.
Current liabilities, also known as current liabilities, are usually closely watched by a company’s management team to ensure that the company has sufficient liquidity – or the ability to cover immediate and short-term liabilities – to cover debts. Examples of current liabilities include creditors, interest payable, income taxes due, bills to pay, short-term loans, bank overdrafts, and accrued liabilities.
Current liabilities can be used as a critical component in assessing how the company is performing financially against the following core ratios:
Current ratio: current assets divided by current liabilities
Liquidity ratio: current assets minus inventories divided by current liabilities
Cash ratio: cash and cash equivalents divided by current liabilities
Non-current liabilities can also be referred to as long-term liabilities because they mature after more than one year. Companies will make a long-term commitment to immediately raise capital to buy, for example, an office building or IT equipment, or to invest in new capital projects.
Long-term liabilities are essential in determining a company’s long-term creditworthiness or its ability to meet long-term financial liabilities. Companies can find themselves in a solvency crisis if they are unable to pay their long-term liabilities as they fall due.
Contingent liabilities are also known as contingent liabilities and affect the company only based on the result of a specific future event. For example, if a business faces a lawsuit, it faces liability if the lawsuit is successful, but not if the lawsuit fails. For accounting purposes, a contingent liability is recognized only when liability is probable, and the amount can be reasonably estimated.
What are Assets?
Assets are everything a company owns, and they are usually on the left side of a balance sheet. There are two types of resources:
- Current assets: These are assets that can be turned into cash, such as accounts receivable and inventory.
- Fixed assets: These are physical items that the company expects to own for more than a year that has financial value to the business, such as tools, vehicles, or computer hardware.
The difference between an expense and an obligation is the operating expense that a company incurs to generate revenue. The main difference between costs and liabilities is that an expense is related to the income of a business. Expenses and income are disclosed in the income statement, but not on a balance sheet of assets and liabilities.
Expenses can also be paid immediately in cash while delaying payment would make the expense a liability.
How do business liabilities work?
A simple way to understand corporate responsibilities is to examine how you pay for your business. You either pay with cash from a checking account or borrow money. All loans create an obligation, including the use of a credit card to pay.
All of your liabilities are shown on your balance sheet, a financial statement showing how your business is doing at the end of an accounting period. Liabilities can be settled over time by transferring money, goods, or services.
To calculate your total liabilities, you can list all your liabilities and add them up.
You can also use a simple accounting formula to find out if your books are balanced. To do this, calculate the liabilities + equity = assets. To be balanced, your total liabilities plus your net worth must equal the number of total assets.
Examples of business liabilities
There are many types of corporate liabilities, both current and non-current. Here are some of the typical examples.
Wages payable: This is the total amount of accrued income that employees have earned but have not yet received This liability often changes because most employees are paid every two weeks.
Interest Payable: Since companies use credit to purchase goods and services, this liability represents interest on short-term credit purchases payable.
Dividends payable: For companies that have issued shares to investors and pay dividends on those shares, this current liability represents the amount due to shareholders after the dividend is declared.
- Deferred receivables: these elements can be recorded as current or non-current liabilities, depending on the transaction and are revenues collected before being earned and recorded on an income statement.
- Post-employment benefits: These are the benefits that an employee or members of their family may receive after the employee retires, which are carried as a long-term liability as and when its accumulation.
- Unamortized Investment Tax Credits: This liability represents the net between the historical cost of an asset and the amount that has already been amortized.
- Warranty liability: This is when there is an estimate of the time and money that can be spent to repair something under warranty.
There are many types of short-term and long-term liabilities that most small businesses will encounter over time.