Whether you’re taking out a loan to purchase a new piece of equipment, or making purchases from vendors on credit — your business is accruing liabilities.
In many cases, liabilities are a regular component of business operations. However, business leaders must strategically manage their liabilities to avoid becoming insolvent or face other financial challenges.
In this article, we’ll discuss what liabilities are, provide common examples, and explore some of the ways companies can expertly manage their liabilities .
What is a liability?
Liabilities are obligations a person or business owes to another entity. It’s often thought of as a ‘debt’ representing a future cash outflow or transfer of something else of value.
Someone may have liabilities in their personal life, though in this guide, we’re discussing the concept through a business lens.
From a business accounting perspective, liabilities are always recorded on the balance sheet. This provides businesses with a snapshot of what they owe other entities in economic terms.
How do liabilities work
The methods for managing and settling liabilities will vary depending on the context and agreement made with the other parties involved.
It usually involves the transfer of money between two parties over time through a one-time payment or series of repayments. However, they may agree to exchange other things of value, like goods or services, to settle the debt.
Either way, the terms set during the event or transaction that created the liability will dictate how the company must manage it. This typically includes a defined payment schedule and due date for settling the liability.
Types of liabilities
There are a few types of liabilities that businesses may see on their balance sheet, which we’ll cover in further detail below
Current vs non-current liabilities
The main way to classify business liabilities is by their due date. Namely, liabilities that are due within one year are considered current liabilities. On the other hand, liabilities that are due it more than one year are called non-current liabilities.
Current liabilities are often used to fuel operations. Thus, given their short time frame for repayment, current liabilities can have a big impact on company liquidity. Some examples include:
- Accounts payable
- Wages payable
- Taxes payable
- Interest payable
- Accrued expenses
- Deferred revenue
Non-current liabilities often provide financing for large purchases or projects. They must be considered in a business’s overall capital strategy, as they typically require the company to make payments for a number of years. Non-current liabilities may include:
- Notes payable
- Deferred tax liabilities
- Mortgages
- Long-term leases
Contingent liabilities
Outside of current and non-current liabilities are contingent liabilities. This is a unique category that accounts for liabilities that could emerge based on future events.
A business will recognize contingent liabilities on the balance sheet if it meets these conditions:
- The outcome is probable
- They can reasonably estimate the amount of the liability
If only one of these conditions are met, the company will not include it on the balance sheet.
Liability vs assets
While liabilities are debts, assets are financial resources the business owns or possesses and can use for economic benefit.
In this way, liabilities are considered the opposite of assets. They’re both recorded on the company’s balance sheet, representing their current financial position. Subtracting the liabilities from the assets provides a measure of the company’s equity or net worth.
The business will take care of its liabilities using its assets. For example, the cash the business has (an asset) is how it will pay off a bank loan (a liability).
So, there’s an important relationship between the two that many organizations will closely monitor to ensure they remain solvent and carry a healthy amount of debt compared to their assets.
Liability vs expenses
Liabilities are also distinctly different from expenses. For starters, expenses are recorded on the income statement, while liabilities are reported on the balance sheet.
Expenses are cash outflows that the business makes to generate income. They have a relationship with revenues, like liabilities do with assets. However, expenses are considered the cost of doing business, while a liability is a debt the business owes.
That said, there can be a relationship between the two. The company can pay an expense immediately with cash. However, if they make a purchase on credit, it will become a liability.
Strategies for managing liabilities
Businesses that don’t properly manage liabilities can face solvency issues, and possibly bankruptcy, if they’re unable to meet their obligations.
Taking on outsized debt or unfavorable payment plans can cause issues for businesses down the line. But, the following helpful tips and strategies are a good way to ensure companies have the ability to pay off their debts on time.
Asset-liability matching
Companies should assess assets and liabilities together, matching up future incoming payments produced by assets with upcoming obligations for liabilities.
It’s a way for businesses to ensure they have the necessary liquidity to cover its near-term obligations.
Aside from cash, teams can take into account any current assets they can quickly convert to cash to cover debt repayments as needed, like inventory, accounts receivable, etc.
Prioritizing high-interest debt
Again, the terms on each liability will differ. In some cases, the interest charged on certain debts will be significantly higher than others, resulting in higher total costs via interest payments.
To minimize liability costs over the long run, companies should prioritize paying off higher-interest debts first.
This includes paying off credit cards or other high-interest loans, tax obligations, and secured debts first. Prolonging payments on these liabilities can lead to higher interest costs, legal penalties, and loss of collateral, depending on the scenario.
Negotiate better terms
In some cases, businesses may be able to renegotiate better terms on debts and liabilities.
Depending on the relationship they have with the other party, they may be able to secure a lower interest rate to reduce total costs or request an extended repayment period to enjoy lower payments every month.
Streamlining payment obligations with BILL
Automated accounts payable systems, like BILL, make it much easier for businesses to meet short-term obligations to vendors and suppliers.
With minimal or no manual entry required, you can quickly enter your bills into the platform, route the appropriate approvals, and time payments to be sent by the due date.
With BILL, you not only have the confidence that short-term liabilities are automatically handled; but, it also gives you a more complete picture of the money leaving your business to power informed decision-making.
Sign up for BILL today to see how the platform can help reduce time spent on accounts payable.
