Bookkeeping 101: Understanding Business Liabilities

What counts as a liability

Liabilities are obligations to pay money or provide goods or services in the future. They appear on the balance sheet next to assets and equity.

If your business received something and has not yet paid for it fully, there is probably a liability. Common examples are unpaid bills, loan balances, credit card balances, sales tax collected and not yet remitted, payroll taxes due and customer deposits received before work is done.

Assets minus liabilities equals owner's equity. See assets, liabilities and equity for the full equation.

Current liabilities

Current liabilities are due within one year, usually within the normal operating cycle. They show your short-term payment pressure.

• Accounts payable: bills from suppliers you have not paid yet.
• Accrued expenses: costs incurred but not billed, such as wages earned this week.
• Sales and payroll taxes payable.
• Short-term loans and the current portion of long-term debt.
• Deferred revenue: cash received for work you have not yet delivered.

Compare current liabilities to cash and receivables to see whether you can cover them. The current ratio does that math.

Long-term liabilities

Long-term liabilities are due after more than a year. They include term loans, equipment financing and mortgages.

Each loan payment usually has two parts: principal, which reduces the liability, and interest, which is an expense. Only the principal reduces the balance. Record them separately so your income statement and balance sheet are both correct.

Here is an illustrative example. You owe $30,000 on an equipment loan and pay $1,000 a month, of which $800 is principal and $200 interest. The liability drops by $800 and expenses rise by $200.

How to record liabilities

Record a liability when the obligation arises, not when you pay. Then reduce it when you pay.

When a supplier invoices you, debit the expense or asset and credit accounts payable. When you pay, debit accounts payable and credit cash. Our guide to debits vs. credits explains the rules.

Keep a simple schedule listing each debt, lender, balance, rate, payment and due date. Update it monthly and reconcile it to statements.

Why lenders and funders look at liabilities

Existing obligations compete with new payments for your cash. Funders check them to judge whether you can afford more.

A business with heavy existing payments has less room for new ones. Know your total monthly obligations and what percentage of revenue they take. The revenue share guide shows how to test an additional payment, and the guide to business debt covers good and bad debt.

Common liability mistakes

The usual errors are forgetting accruals, mixing up principal and interest and leaving paid balances open.

Three problems appear again and again. First, owners record bills only when they pay them, so payables are understated and profit looks higher than it is. Second, loan payments are booked entirely as expenses, which hides the true loan balance. Third, sales tax or payroll taxes collected are treated as income instead of money owed.

A monthly check helps. Compare your liability accounts to lender statements, vendor statements and tax account balances. Any difference needs an explanation.

If you are unsure, ask an accountant to review your chart of accounts once. A short review early can save hours of cleanup later and gives you balance sheet numbers a funder can rely on.

Using debt on purpose

A liability is not bad by itself. Borrowing makes sense when the money produces more than it costs.

The question is payback. If $50,000 of working capital produces $80,000 in extra gross profit and costs $8,000, the math is clear. If it produces nothing new, it only adds a payment.

ROI Funder helps owners compare options such as term loans and working capital with true cost and monthly-equivalent payments shown first. We consider 500+ FICO, 6+ months in business and $20,000+ monthly revenue.