Liabilities are one of the three foundational components to business bookkeeping. They are what your business is financially obligated to pay. They can take the form of services owed or money owed. Simply put, they are what your business owes customers, employees, or vendors.
Why Are They important?
Owing money is not a bad thing. Sometimes loans are required to purchase assets. Liabilities can give small businesses the funds need to operate and grow their business. However, you want to ensure you do not take on too much liability as a business. You should always have enough value in the Assets of your business to offset the cost of your business’ Liabilities. Understanding your businesses Liabilities is key to managing money and maintaining a financially healthy business.
What Are Some Small Business Liabilities?
Almost every small business is going to have Liabilities. They fit into two categories, Current Liabilities and Long-term Liabilities.
Current Liabilities - These are financial obligations due within 1 year.
Common Current Liabilities
Accounts Payable - This generally shows the amount your business owes other businesses for services or products provided. Think of a cell phone bill that has yet to be paid. Until it is paid, the amount owed is booked to Accounts Payable.
Tax Liabilities - These are tax categories that are owed but not yet paid. Think of Sales Tax owed. Once paid, they move to Taxes Paid categories.
Unearned Revenue - This is for payments received from customers for service in advance. If a customer prepays for an entire year of service, any amount for service in future months is unearned revenue. Once the revenue is earned, it moves to the appropriate income category.
Credit Cards - Money owed on your business credit cards.
Current Portion of Long-term Debt - This is the amount of principal on long-term loans due within the next 12 months. If you have 5 more years to pay off a loan, whatever is due within the next 12 months is reflected here.
Long-term Liabilities - These are financial obligations that are not due within the next year.
Common Long-term Liabilities
Notes Payable - These are loans to the business. This will be the total amount of principal due to lenders. I would recommend having a Notes Payable account for each loan to the business.
Less - Current Portion of Long-term Debt - This account will be either $0 or a negative amount. It is the amount of Long-term Debt that will be paid within the 12 month. Note: this amount should be the negative equivalent of the Current Portion of Long-term Debt account.
Some Helpful Tips
In order to have accurate books, you have to be diligent with updating your bookkeeping records. The more you fall behind, the harder it is to catch up and ensure your books reflect your business’ finances accurately. Here are some tips to keep your books up-to-date:
Record bills as they come in and record payment of those bills as they happen. Your accounting software should make sure your Accounts Payable is accurate as long as you enter the bills and payments as they happen.
When recording payments toward Loans in your accounting software, be sure to accurately input how much of the payment went toward the principal and how much went toward interest. This will ensure the Notes Payable balance is accurate and also record the interest expenses you accumulate.
Note: Some Credit Card companies may need you to record payments in your accounting software this way as well.
Make an adjusting entry at the beginning of each month to show how much of your Long-term Debt is due within 12 months and how much is due 13 months and beyond. This will help you to accurately reflect what is your Current Portion of Long-term Debt and what is not. Keep your eyes open for an upcoming post on Current portion of Long-term Debt.
There You Have It..
That is Liabilities in a nutshell. They are one of the big three elements in bookkeeping for your business. Knowing what they are allows you to understand what they mean on your books. Accuracy in recording your liabilities is essential to managing your business’ money and ensuring it remains financially healthy. Be sure to record bills and their payments in a timely fashion, record principal and interest payments on loans accurately, and adjust the Current Portion of Long-term each month.
Keep in mind, as a bookkeeping professional I am trained in handling all aspects of bookkeeping, including Liability Accounts. Feel free to schedule a free consultation to see how I can make your life easier and offload your bookkeeping tasks.