What are Liabilities in Accounting?

December 2, 2021 Cash Flow, Entrepreneurs, Financial Strategy

If you’re here, you’re wondering, “What are liabilities in accounting?” Simply put, liabilities in accounting are the organization’s financial obligations.

But what does this mean exactly?

Companies have liabilities that are outlined in their balance sheet. These include but aren’t limited to the money a business owes to suppliers, loans owed, wages payable, and more.

Basically speaking, liability in financial accounting is a company’s financial responsibility. Most of the time, small businesses may have liabilities like money owed to suppliers to consider. But other liabilities exist, of course.

Understanding Liability on a Balance Sheet

How Are Liabilities Listed on a Balance Sheet?

A company’s balance sheet should contain its liabilities. This is a common financial statement that’s generated by a professional or using financial accounting software. We in the industry refer to this as “payables.”

Every business has liabilities – except for those that operate strictly with cash. The operations using cash must pay with and accept it, whether it’s physical cash or via the company’s business checking account.

As you look at your company’s balance sheet, you’ll notice your assets and owners’ equity. Liabilities in accounting equals the value of assets minus owners’ equity. Your assets always will equal your liabilities plus owners’ equity, just as your owners’ equity will always equal assets less liabilities.

Accounts Payable Liabilities

Accounts Payable Liabilities

Accounts payable is a liability because this is the amount of money that’s owed by your business. It should be listed under the current liabilities on your company’s balance sheet.

This can include a loan you made to the business to get it started, a loan you received from a creditor, a product you took on credit, etc. All of these should be listed on your balance sheet.

Your balance sheet or financial statements should include accounts payable. All current liabilities are relevant, including long-term liabilities and contingent liabilities. Even though contingent liabilities aren’t considered a current liability, they’re equally important to consider.

Using Financial Statements to Uncover Liabilities

Looking at your financial statements, you should have no trouble viewing your current liabilities. Whether short or long-term liabilities, they should be listed, including interest payable.

Here’s a list of items you should consider liabilities:

  • Accounts payable (any money owed to suppliers)
  • Salaries owing
  • Wages owing
  • Interest payable
  • Income tax payable
  • Sales tax payable
  • Customer deposits or pre-payments for goods or services not provided yet
  • Lawsuits payable
  • Debt payable
  • Contracts, like a cell phone contract that can’t be canceled without penalty
  • Lease agreement
  • Insurance payable
  • Benefits payable
  • Taxes on investments
  • Accrued liabilities (such as interest owed that hasn’t been billed by the lender yet)

How to Minimize Current Liabilities

How to Minimize Current Liabilities

Minimizing current liabilities is essential for organizations, especially when considering your operation’s financial place. Tracking every aspect of your business’s net worth will ensure you know whether your operation is getting ahead or falling behind.

But how can you minimize current liabilities?

By tracking your financials, you’ll know your business’s net worth. If it’s in the positive, this is ideal. The equation is simple; your operation’s net worth is equal to your most liquid assets minus your liabilities.

Review your business’s spending to learn more about its financials. Make sure to pay down any debts as this will lessen your current liabilities and free up more money every month.

The key here is to decrease unnecessary spending and review where your capital is going. By focusing on your company’s debt, you’re avoiding adding to its debt balances monthly. Then, it’s all about decreasing current debt on your balance sheet and avoiding long-term liabilities when possible.

Organizing Debts & Decreasing Long Term Debt

The snowball method works well for getting a company out of debt. You’ll organize your debts and accrued liabilities from the smallest balance to the largest, paying the minimum on all debt besides the smallest.

For the smallest contingent liability, you’ll pay as much as possible. After paying it off, you’ll do the same for the next smallest debt.

By doing this, you’ll remain motivated as you make some progress. You’ll minimize your liability accounts and current liability this way as you continue to increase your accounts receivable and other current assets.

Restructuring Liabilities

Restructuring Liabilities

You have accrued liabilities that have been growing over time. But there are ways to restructure your liabilities and get your accounting equation into the positive.

Your company’s liabilities include all of the money owed to other people, including but not limited to your vendors. However, keep in mind, just because you restructure your liabilities doesn’t mean you’ve reduced how much you owe. But it can ensure you have more cash on hand, increase your disposable include, and/or lessen how much debt you need to obtain working capital.

Here are some methods to restructure your liabilities and reduce your debt:

  • Change to longer or scheduled payment terms with your suppliers
  • Replace your existing loans
  • Defer tax liabilities

For replacing existing loans, you have a few options. You could find a bank loan with a lower interest rate, or you may opt to replace unsecured loans with secured ones to lessen the interest rate.

Short-term loans are also considered a financial obligation. But a short-term loan for a small business can enhance the short-term financial health of the operation.

Replacing loans with guaranteed loans can also reduce your interest rate. But you also have the option to make repayments over a longer period of time, consolidate your loans, and use shareholder funds to reduce your debt.

Restructuring Assets

Just as you can restructure your liabilities, you can also restructure your assets. You could, for example, sell some of your fixed assets to lessen the long-term liability on your balance sheet.

You could also convert some of your necessary assets into liabilities. For instance, sell them to a finance company and lease them back.

Factoring invoices is also a good method for reducing the asset value of the invoice while raising cash. And you also might have the option to use investments or cash to pay back your loans.

Raising More Capital

Raising more capital is also an option to handle accrued liabilities and other long-term debt. While short-term liabilities and long-term debt may be off-putting to some, you may have the option to find more investors.

In some cases, issuing more shares to current investors may be the best solution to short-term debt and long-term debt. You may also have the option to borrow money from a lending institution or use accounts receivable factoring.

When it comes to considering your current liability and long-term debt in accounting, there are a few key things to remember. First, liabilities are all of the money that your company owes to other people. This includes debts, accrued expenses, and other short-term liabilities.

You may be able to check your asset list to determine whether you can convert them into more valuable assets. For instance, if your company owns the land its building is on, you may have the option to build offices or houses on that land.

If all else fails, you could always exit the business. This could involve selling your operation, going into receivership, or selling off your assets and utilizing the proceeds to handle all long-term liabilities and each current liability listed on your balance sheet.

FAQ for Liabilities in Accounting

What are examples of liabilities?

Some common liabilities include notes payable, accounts payable, accrued expenses, and income taxes payable.

What is the best way to reduce liabilities?

There are a few different ways to reduce liabilities. One is to restructure them, which can include changing the terms of your agreements with creditors or renegotiating loans. You could also raise more capital or sell assets.

What is the purpose of liabilities?

Liabilities are important because they show how much money your company owes to other people. This can include debts, accrued expenses, and other short-term liabilities. As a business owner, it’s important to keep track of these numbers and make sure you’re doing everything possible to keep them under control.

What are the different types of liabilities?

Some common forms of liability include notes payable, accounts payable, accrued expenses, and income tax payable. You may also hear these referred to as accounts payable.

Who creates a balance sheet?

A company’s accountant is responsible for creating a company’s balance sheet at the end of the fiscal year. However, as a business owner, you should be aware of how it works and what it includes so you can make informed business decisions.

What is the difference between liabilities and equity?

Liabilities are considered to be money that your company owes to other people —including debts, accrued expenses, and other short-term liabilities. Equity, on the other hand, is the money that your company is worth. This includes the total value of all of your assets minus all of your liabilities.

What is the difference between a long-term liability and a short-term liability?

Short-term liabilities are those that need to be paid within one year. Long-term liabilities are those that need to be paid over a period of more than one year.

What is the difference between a liability and a debt?

Debt is a specific type of liability. A debt is an amount of money that is owed to another person or entity.

What is the difference between assets and liabilities?

Liabilities are considered to be money that your company owes to other people. Assets are considered to be anything of value that your company owns, including cash, equipment, inventory, accounts receivable, and property.

What is meant by liabilities in accounting?

When a company refers to its liabilities in accounting, it means all of the money it owes to other people. This includes debts, accrued expenses, and other liabilities.

What are the four types of liabilities?

The four types of liabilities are notes payable, accounts payable, accrued expenses, and income taxes payable.

What is the primary focus of a balance sheet?

The primary focus of a balance sheet is to show a company’s financial position at a given moment in time. This includes detailing the company’s assets, liabilities, and equity.

Closing on Liabilities in Accounting

As a business owner, it’s important to understand the difference between assets and liabilities, because these numbers can affect your business’s debt load. The economic benefits your operation experiences could vastly differ depending on your liabilities.

If you would like to learn more about how liabilities work in accounting for cannabis growers and other cannabusinesses, feel free to contact us at Northstar. We implement generally accepted accounting principles while thinking outside of the box to create custom-tailored financial solutions for your business.