10 Small Business Liabilities that Every Owner Should Know About

Where is your company at risk because of small business liabilities you are overlooking? Even if you are proactive in business systems and processes, it’s possible that a few holes could be putting your cash flow at risk. Every business owner needs to be proactive in identifying these potential issues before they become more serious financial problems in the future.

What are Small Business Liabilities?

Liabilities are any obligations that you owe money on. Sometimes, liabilities require current payments, such as loan installments or credit card monthly payments. At the same time, these obligations can be owed in the future, depending on your agreement with the lender.

Liabilities are recorded on the right side of your accounting balance sheet – indicating that it’s money that you owe. Examples of small business liabilities might include:

  • Accounts payable
  • Loans
  • Mortgages
  • Bonds
  • Accrued expenses
  • Warranties
  • Mortgages
  • Payable dividends
  • Interest owed
  • Employee wages

Any time you have an agreement with another business or provider, and this contract isn’t paid for yet, it falls in the category of small business liabilities. These liabilities can fall in the short term category (typically less than 12 months), or the long term category (a payment schedule that extends beyond a year).

Another possible form of small business liability you might have is products or services owed to others. For example, if you have promissory agreements for the delivery of certain services or products, then it would be considered a liability since it impacts your cash flow in the future.

Type of Small Business Liabilities

The only time a business might not have liabilities is if the company only pays with cash and only accepts cash payments. Since we live in a digital business environment, it’s nearly impossible for a company to thrive on cash alone. As a result, it is common for small businesses to have liabilities. These liabilities aren’t a bad thing – as long as the liabilities and cash flow are managed correctly.

Small business liabilities fall into three categories:

  • Current Liabilities: Examples include accounts payable, credit lines, loans and salaries. Anything that needs to be paid within a few months (up to a year) is considered a current liability. Since these liabilities need to be paid quickly, they are watched closely to be sure that you are managing your cash flow and current liquidity. Your accounting team can assist in keeping an eye on current liabilities so you always have enough to cover both immediate obligations and upcoming payments.
  • Long Term Liabilities: On the other hand, certain liabilities require ongoing payments over an extended period of time. Examples of long-term liabilities include large equipment purchases, mortgages, or bonds. Long-term liabilities play a role in the solvency of a business in the future. For example, immediate capital can be obtained through financing to purchase equipment or real estate. Eventually, these financial obligations need to be paid, which means that a business could be facing serious financial issues if cash isn’t available when these long-term obligations become due.
  • Contingent Liabilities: Certain costs only need to be paid based on specific outcomes, so these liabilities fall in the contingent category. An example of when a liability depends on a future event is the outcome of a lawsuit or legal case. For example, you could potentially have a liability that needs to be paid out if the ruling is not in your favor at the end of the legal proceedings. From an accounting perspective, contingent liabilities are only recorded in the books if you have a reasonable estimate for the amount and there is a high likelihood that the liability will come through in the future.

Assets and Liabilities – What You Need to Know

Both assets and liabilities affect your business balance sheet, so it’s important that you understand how these two factors work together. When the numbers are accurate and up-to-date, you can run accounting reports to see the overall financial health of your business.

Assets are things that your business owns that bring value to the company. Examples of assets include real estate, equipment, cars, accounts receivable, etc. Assets can fall into several categories:

  • Current Assets: These assets are things that you could turn into cash quickly if needed. For example, if cash flow was tight, then you could sell more inventory to bring in the money that is needed. Another example of a current asset is your accounts receivable – the outstanding invoices that will be paid by your customers.
  • Fixed Assets: Anything that you will own for a long time falls in the category of fixed assets. Examples include computer equipment, construction equipment, vehicles, tools, real estate, etc.
  • Intangible Assets: You don’t have to receive a physical item or service to consider something an asset for your business. Intangible assets are resources that have financial value without a physical form, such as brand recognition or a copyright held by the business.

If you want a clear picture of the financial standing of your company, then it’s important to calculate the assets and subtract the liabilities. Additionally, consider how ongoing expenses will affect your cash flow right now and in the future.

How are Liabilities Different than Expenses?

It’s easy to assume that “liabilities” and “expenses” are synonyms. But there are distinct differences between the ways these costs are recorded and managed in your accounting system. An expense is a category used for anything that is required for the cost of operations. If you need to spend money to generate revenue, then it would be considered an expense (not a liability).

Examples of expenses include office supplies, rent, utilities, employee payroll, or anything else that needs to be paid so your company can stay in business. These expenses are typically paid quickly in cash. If any of these payments are delayed because you are offered credit from a provider, then the line item shifts from an expense to a liability. The simplest way to see the difference between these categories is by looking at how you pay for something that is needed for your business. If you are paying the bill from the cash in your checking account, then it is an expense. If you need to borrow money or use credit for the purchase, then it creates a liability.

Revenue and expenses are shown on your income statement, but they aren’t listed on a balance sheet that compares your liabilities and assets.

Accounting Formula for Your Balance Sheet

Do you want to know how much your business is worth? Whether you are looking to bring on investors or you might be selling the business in the future, you need to have a clear idea of the value of your company. This value can be calculated by looking at your small business liabilities and assets. The calculations show the current financial strength of your company.

The “basic accounting equation” (also known as an accounting formula) can be used to calculate the net worth of your company. You can figure out this amount by using this formula:

  • Assets – Liabilities = Equity

First, you need to calculate total assets and total liabilities. Then, subtract the liabilities from the assets to see how much equity is left. If you have more liabilities than assets, then this equity number will be negative. If you have more assets than liabilities, it shows that your business has good financial health because you are in the black.

While business debt is sometimes required, the goal is to maintain positive equity. The higher your equity number, the better financial health your business is experiencing. If you do this calculation and see that you have a negative number on your balance sheet, then it is an indication that your company is in trouble that you need to be proactive about turning things around. The principles are the same, regardless of your industry: increase assets and pay off liabilities whenever possible.

Professional Accounting Services for Reviewing Your Balance Sheet

It’s smart to review this balance sheet regularly so you have a clear understanding of the current health of your business. You need to know your financial standing before making bigger decisions related to hiring, inventory management, and more.

The best thing you can do is hire an experienced accounting team to review your balance sheet periodically. We can make sure your small business liabilities aren’t growing faster than your assets. Watching the trends over time can be an important step in catching potential cash flow issues in the earlier stages – then you can make changes right now to improve your balance sheet in the future.

Trusted Accounting Services for Small Businesses

If you need accounting support for your small business, then Easier Accounting is available to assist. We focus on small business services, giving you the peace of mind to know that you are working with a team that understands your business needs. We offer more than balance sheet calculations – our team can also help with tax strategy and preparation, payroll processing, and more. You can learn about these services by calling us for a consultation: (888) 620-0770.

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