As a business owner, one word that you must have heard and come across when maintaining business statements is liability. When creating a balance sheet or a financial statement, you must have seen two different sections for assets and liabilities. So, the question is: what is a liability? Here, in this article, we are going to tell you everything that you need to know about liabilities.
Understanding the definition of liability
Simply put, it’s something you or your business owes, whether that’s money, goods, or services, to another person or company. Usually, you’ll pay it off in the future. You settle liabilities by handing over cash, goods, or maybe by performing a service. On a company’s balance sheet, liabilities show up on the right side. These aren’t just limited to loans; they include accounts payable, mortgages, deferred revenues, bonds, warranties, and any expenses you still owe.
If you think of assets as what you own (or what people owe you), liabilities are just the opposite; they’re what you owe or have borrowed. Two of the biggest liabilities you’ll see on a company’s books are accounts payable and bonds payable. Almost every business has these.
Understanding the Mechanism of Liability
After knowing the liability meaning, you should also know that liabilities mainly arise from past transactions and showcase future obligations that you need to pay. Liabilities can be categorized into two categories: current and non-current based on their status and temporality.
Liabilities aren’t just a necessary evil; they keep companies running. The money is used by businesses to fund their everyday operations and pay for expansions. They can also streamline business transactions. Let’s say a wine supplier drops off a case of wine at a restaurant. The restaurant doesn’t fork over the cash right away.
Instead, the supplier sends them a bill, which makes life easier for the restaurant and speeds up the delivery process. Until the restaurant pays, that bill sits on its books as a liability. On the flip side, the supplier counts the money it’s going to receive as an asset.
What are current and non-current liabilities?
As mentioned, it is very important to know about the two categories of liabilities, as every liability that your business has falls under these two categories.
- Current Liabilities
Now, not all liabilities are created equal. Current liabilities are the short-term stuff—bills or debts you’ll need to pay within a year. Think payroll, payments to vendors, or your monthly utilities. Analysts like to see companies settle these quickly, typically with cash on hand. These include everything from wages payable and interest payable to unearned revenues and liabilities of discontinued operations.
- Non-current Liabilities
Anything you don’t need to pay within a year falls under non-current, or long-term, liabilities. Long-term debt, often in the form of bonds payable, usually sits at the top of this list. Lots of companies, big and small, fund their long-term activities by issuing bonds, basically borrowing money from whoever buys those bonds. That part of the balance sheet never stays still, since bonds are always being issued, paid off, or called back by the company.
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