Understanding Liabilities

For a fledgling business or when you’re starting out as a contractor, important financial documents from the balance sheet on upward can be difficult to read and interpret. In fact, every so often we’ll talk to a new client who’s been having difficulties for multiple years simply because some part of these reports is still opaque to them. This week we thought we’d spotlight something that can be a real problem if it’s misunderstood or neglected; liabilities.

What are Liabilities?

Every debt or financial obligation your business has not yet met will show up on a balance sheet as a liability. So if you have rent or utilities upcoming, those are liabilities; if you’ve engaged a team to promote your website and their invoice has yet to be paid (or received), that’s a liability. Dividends payable from profits are also liabilities. On your balance sheet these are what balance against assets; the result can be thought of as the company’s current value. More importantly, tracking liabilities fully makes it much easier to plan for outgoing spend as each one comes due. The first step in breaking down liabilities is between current and long-term liabilities.

Current vs. Long-Term Liabilities

You can think of current liabilities as those obligations you’ll need to settle in the next accounting period. This is almost always defined as the twelve months following the date of your balance sheet. This includes instalments of longer obligations, etc. As you might expect, long-term liabilities are all existing obligations which are not due in the next twelve months. It’s worth remembering that deferred income is also treated as a liability; that is, if you are paid in advance, then the value of those goods or services is considered a liability until these are delivered. After all, if something prevented you from delivering those goods or payments, you’d need to reimburse the customer. However, if all is well, these won’t be paid for from your cashflow but through either your stock or your work. Many businesses therefore highlight deferred income as its own category when assessing their balance sheet as a whole.

Liabilities and Cashflow

You should be able to repay all current liabilities within the next twelve months, but of course much of it will have tighter repayment figures. We recommend cross-referencing your current liabilities against a planned schedule of payments; combined with the dates for expected incoming payments, these give you a detailed understanding of your cashflow and can be essential in planning any additional expansion or other major expenditure. If you’re having difficulty tracking your financials, just get in touch and we’ll be happy to help.