In financial terms, a liability is what is owed by a person or company. Liabilities can be short term or long term, depending on how long it will take to pay back. They are the opposite of assets, in that assets are what a company owns and liabilities are what a company owes. Liabilities can include money, goods, or services and are expected to be settled over time.
How Does a Liability Work?
Liabilities are financial obligations between entities that are not yet completed. These obligations can be both physical and non-physical. Liabilities are included in a company’s balance sheet and are usually listed by due date. It is expected that they are paid back, whether that is in the short-term or long-term future.
What Is an Example of a Liability?
Some examples of liabilities can include money that was borrowed from a bank, rent on a building or property, payroll to employees, and taxes owed to the government. Other examples can include a service owed to another company or institution or a potential lawsuit.
Why Do Your Liabilities Matter?
It is important to track your liabilities because most financial institutions will want to know that a company or person can pay back or settle their liabilities. A company’s liabilities added to their shareholder’s equity should equal their assets at a specific moment in time.
What Are Long-Term Liabilities?
Simply stated, long-term liabilities are obligations that are expected to be paid back after one year. They are also sometimes referred to as non-current liabilities. Long-term liabilities are listed separately on balance sheets, usually after short-term liabilities.
This can change if a company plans to refinance a long-term liability. If this is the case and it is documented with proper evidence that refinancing has started, a company can list a long-term liability as a short-term or current liability.
What Are Short-Term Liabilities?
Short-term liabilities are also referred to as current liabilities. They are expected to be paid off within the financial year, or within 12 months. Short-term liabilities are listed separately from long-term liabilities on a company’s balance sheet, although both are under the liabilities section. Accounts payable (AP) are usually responsible for the largest portion of short-term liabilities.
Types of Liabilities
There are two main categories of liabilities that include short-term liabilities and long-term liabilities. These two categories can each be broken down into several subcategories. Let’s review them below.
Current liabilities, also referred to as short-term liabilities, are financial obligations that are expected to be paid off within a 12 month timeframe or within an operating cycle.
The typical operating cycle of a company is the time it takes for that company to convert its inventory into cash from sales. For short-term liabilities, this is expected to occur within the year. Current liabilities include accounts payable, taxes payable, notes payable, and short-term loans.
Accounts payable (AP) is money owed by a company to suppliers or creditors. AP can include services, office supplies, or other categories of products similar to bills. Managing AP is crucial in showing a company’s management of cash flow.
Accounts payable are different from accounts receivable in that they are the opposite of each other. Accounts payable are what a company owes to others and is noted as a liability. On the other hand, accounts receivable are what is owed to a company from others and are noted as assets.
Taxes payable, or income tax payable, is a list of taxes due to the government within one year. They are listed on a company’s balance sheet as a current liability, since they are expected to be paid within 12 months. They are also used to calculate deferred tax liabilities, which are dependent upon the company’s home country.
Notes payable are written agreements between two parties in which one party agrees to pay the other party a certain amount of money. It will contain the amount to be paid as well as the date it should be paid by. Notes payable are similar to written promises between two companies.
A short-term loan is a current liability because it is expected to be repaid quickly. Short-term loans are similar to a type of credit and involves the amount borrowed as well as interest to be paid back. They can be a good option for start-up businesses that are not eligible for a credit line through a bank. They can also be used for individuals who find themselves in financial difficulties.
The opposite of current liabilities, non-current liabilities are long-term and not expected to be paid back within the upcoming year. They are listed along with short-term liabilities on a company’s balance sheet and used to represent long-term obligations. Non-current liabilities include bonds payable, long-term leases, and deferred tax liabilities.
Bonds are issued through investment banks and are considered non-current liabilities if the payment agreement is greater than one year. A bond is a form of long-term debt and is usually one of the largest liabilities listed on a company’s balance sheet. They are a kind of lending agreement between a lender and borrower.
A long-term lease is considered a liability when the term of the lease is greater than one year. They are usually used to purchase fixed assets, such as equipment needed to run the business. Any property purchased using a long-term lease is recorded as an asset on a company’s balance sheet.
Deferred Tax Liabilities
Taxes that a company has not paid back within a current period of time are referred to as deferred tax liabilities. They are expected to be paid back in the future. Deferred taxes are calculated using the difference between accrued tax and taxes payable.
What Are Contingent Liabilities?
A contingent liability is listed on a company’s balance sheet if the amount of the liability can be estimated and if it is probable that it will be paid back. Contingent liabilities are financial obligations that might have to be paid back but the details are not quite finalized yet. Examples of contingent liabilities include lawsuits, product recalls, or unused gift cards.
What Is an Asset?
An asset is something that can be used to produce value by an individual person or company. There are several types of assets, all of which can provide economic value. An asset is expected to provide a future economic benefit by increasing a business’s or person’s value. Assets are recorded on a company’s balance sheets, along with the company’s liabilities, and used to show equity.
What Is the Difference Between Liabilities and Assets?
Liabilities are different from assets in that they are what a company owes. Assets are what a company owns and provide value to the company. Both assets and liabilities are recorded on a company’s balance sheet and used to show the company’s overall financial value. A company’s total liabilities should equal the difference between their assets and shareholder’s equity. This can be conveyed by the following equation:
LIABILITIES = ASSETS – SHAREHOLDER’S EQUITY
How To Manage Your Liabilities
Keeping detailed records of what you or your company owes is one way to keep your liabilities under control. If they are not managed properly and a company does not acquire additional assets to balance, they could see their equity decrease.
Working With a Financial Advisor to Manage Liabilities
It is important to remember that liabilities are what an individual or a company owes. Liabilities can be short-term or long-term with the expectation that they are going to be paid back or handled. They are expected to provide financial benefits over time.
Financial advisors are available to help you obtain the information you need to understand liabilities. Working with a financial advisor can help you manage and keep track of your liabilities, as well as your assets and equity.