Understand company liabilities how to identify them and classify what you owe!
Company liabilities and balance sheets are made up of three parts; assets, liabilities, and equity. All three are important and provide a financial gauge for your company. Liabilities are almost contrary to assets. Instead of things that the company owns monetarily (or physically), it is money that the company owes to others. Many times, assets and liabilities will be intertwined with each other.
For example, if you buy a new truck, that truck is an asset. However, you likely took out a loan to buy that truck resulting in a liability or money you owe someone. The fact that you have a $10,000 truck is offset by the fact that you owe $8,000 on the truck, meaning you only have $2,000 of value in the truck at the end of the day.
Like assets, liabilities break down into several options, including accounts payable and credit cards being your current liabilities followed by other current liabilities and long-term liabilities. Again, just like assets, these break down into different areas this time, though it’s based on when the money is coming due, not how liquid the assets are.
Credit cards and accounts payable show up at the top of liabilities as these are coming due the quickest. Most of these will be due within 30 days unless you have a generous vendor. You’ll need to plan on having the capital to pay these off immediately; otherwise, you risk your credit and could incur financing fees. At no point in time should these accounts exceed your liquid capital. If they do, you should immediately take action to curb expenses or increase sales while identifying the deficiencies in the business. This is one of the reasons why reviewing and understanding your financial statements monthly is vital to the success of your business. It helps you catch these issues quickly and correct them, not wait until they become too big of a problem.
Other Current Assets
Next, we move to other current assets, which will be coming due in the next year, just like credit cards. Anything that is a current asset, you need to plan on paying in the next year. The easiest way to distinguish current assets from long-term assets is: what is coming due in the next year? Common current assets will include payroll liabilities like taxes, healthcare, and other benefits, along with monthly premiums or payments.
Though you don’t need to make sure to have the money in the account today to cover these company liabilities, you do need to make sure that the money you are bringing in is being set aside to cover these payments. If you don’t, you will run into cash flow issues at some point in time. Many businesses forget to do this, and when they pay these liabilities down, they wonder where the money went even though they had a profitable month.
Just because on an income statement your month is profitable does not mean that your bank accounts increased or that you have more money.
One current liability that many don’t consider is any loan payments coming due in the next year. While loans may be long-term and can last for three, four, five, or even 30 + years, they require monthly payments that need to be addressed and accounted for.
Those payments will come every month unless you defer or default on the loan. It would be best if you planned on having 12 of those payments ready throughout the year, which is why they sit in current assets. Any time you have a loan, that loan should be split between the long-term debt and the debt coming due over the next 12 months so that you understand the breakdown and have the correct cash set aside.
The last liability account is long-term liabilities which act as it sounds. It shows your debts owed over an extended period. These debts could easily be infinitely owed or for a period of three to five years with no distinction other than your knowledge on the accounts. Long-term liabilities are there to show what you owe others vs. the assets you have in the company. Having more liabilities than assets is not always a bad thing. You could take out a line of credit to expand the business but not immediately see the returns. Yet long term, unless you are going through an expansion point, assets should exceed liabilities. For businesses selling as a turnkey business, this can be a huge factor in the money you can get out of the sale. This is due to the debt that transfers to the new business owner in some cases. It is important to keep track of this information to understand your ratios as a business and prepare for the business’s eventual sale.
Company Liabilities are just one of the three types of accounts to look at when considering your balance sheet. All three interact together and result in a cohesive report, the easiest way to look at this is that assets equal liabilities plus equity (assets=liabilities + equity).
In other words, if your liabilities increase, more than likely, your assets will increase. Vice versa, if liabilities go down, assets will go down, or your equity goes up. Everything is connected in the long run. Make sure to read our Balance Sheet, Company Assets, and Company Equity to get a full grasp on how these all work together. Or call us for customized training for you!
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