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FINANCE, BUDGETS AND CASHFLOW
What is a liability in accounting?
In accounting, a liability can be defined as something a business owes. This typically involves money, services or goods. In most cases, liabilities are created by past transactions or events, and are settled through transfers of the commodity in question.
For example, if your business has borrowed money, owes suppliers, or has unpaid bills, those are all considered liabilities.
In this guide, QuickBooks accounting experts will explore how liabilities apply to business accounting, where you might find your business liabilities, and what some common examples of liabilities are. We’ll also run through some key tips on how to manage liabilities as part of your cash flow operations.
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How do liabilities apply to business accounting?
In classic T-accounts, liabilities appear on the right-hand side of the balance sheet, opposite assets, which represent what the business owns. Together, liabilities and assets help paint a clear picture of a company’s financial health.
As such, they are also central to the accounting equation: Assets = Liabilities + Equity. This equation ensures a company’s books are balanced, and will show much of the business is financed through borrowing or obligations, rather than the owner's own funds.
With this knowledge in mind, business owners can fund operations, invest in growth, and manage cash flow. It means they can operate smoothly without needing to tie up large amounts of capital in every purchase.
However, it’s crucially important to track and manage liabilities properly. While they are often necessary for growth, high levels of unpaid debt can threaten the long-term stability of your venture and reduce its value.
Types of liabilities explained
There are many different types of liability that are common in business accounting. Some, like unpaid invoices or business loans, are relatively straightforward. Others rely on future events occurring, or are more complex in composition.
Generally, liabilities can be categorised into one of two categories: current or non-current, based on how long it will take to settle.
Current liabilities vs. long-term liabilities
Current liabilities
Current liabilities are short-term debts or obligations your business expects to settle within 12 months. These typically include things like accounts payable, wages owed to employees and short-term loans.
These are part of the day-to-day running of your business and can change frequently depending on activity and seasonality.
Long-term liabilities
Long-term liabilities, on the other hand, are obligations that extend beyond one year. These might include, for example, mortgages on business property, lease obligations and bonds payable.
These types of liabilities are often associated with funding large investments or growth plans and are repaid gradually over time.
What is a contingent liability?
A contingent liability refers to a potential liability, rather than an actual liability. This is because it depends on the outcome of a future event.
For instance, should your business be sued and there’s a chance you may have to pay damages, this is a contingent liability. Although you wouldn’t have to settle anything at the present time, there is a possibility that you’ll need to in the future.
Even if a liability is not guaranteed, it needs to be disclosed in your financial statements to ensure it is accounted for.
How do I know what my business liabilities are?
To know what your liabilities are as a business, you’ll need not only to know what you owe at the current time but everything you’re going to owe in the medium and long term.
A good place to start is by reviewing your key documentation that is likely to feature this information. These include your:
Balance sheet – This lists all your liabilities, which are typically separated into current and long-term categories.
Invoices and supplier agreements – These reveal amounts owed to vendors and partners.
Loan documents and contracts – These show long-term commitments, as well as interest terms and payment schedules.
Payroll and tax records – These indicate any wages, taxes, or pension contributions due.
So how can you use this information to calculate your liabilities and assets?
How can I calculate my liabilities?
To calculate your liabilities, you can add together all the amounts that your business owes. The following three formulas will help you to assess the proportion of assets and liabilities that your company has.
The debt ratio
The debt ratio measures the proportion of a company’s assets that are financed through liabilities.
Formula:
Debt Ratio = Total Liabilities ÷ Total Assets
A higher ratio means a business relies more on borrowed money, which can be riskier. A lower ratio indicates more financial stability.
The long-term debt ratio
This ratio focuses only on long-term debts in relation to total assets. It shows how much of your business’s assets are financed by long-term borrowing.
Formula:
Long-Term Debt Ratio = Long-Term Liabilities ÷ Total Assets
This is especially useful for understanding your long-term financial commitments and assessing your ability to cover them with existing assets.
The debt-to-capital ratio
The debt-to-capital ratio compares your debt to the total capital available (which includes debt and equity). It tells you how leveraged your business is.
Formula:
Debt-to-Capital Ratio = Total Debt ÷ (Total Debt + Shareholders' Equity)
This is a key ratio for investors and lenders, as it shows how much of your business is financed through debt versus equity. A balanced ratio can indicate sustainable growth, while a high one may signal financial stress.
How do I calculate total assets?
Your assets as a business include tangible and non-tangible items. In short, it is anything that could be sold, used to generate income, or provide future economic benefit.
To calculate your assets, you’ll need to use the following formula as outlined above:
Assets = Liabilities + Equity.
This is known as the accountant’s equation, and it forms the basis of your balance sheet. It shows that everything a business owns (assets) has been financed either through borrowing (liabilities) or through investment from the owners (equity).
Examples of liabilities
Businesses come in many shapes and sizes, and so do their liabilities. There are lots of varying types of liability that a business may encounter, and just some examples include:
Bank loans – Borrowed money that needs to be repaid over time.
Overdrafts – When a business bank account goes below zero, the overdrawn amount becomes a liability.
Accounts payable – Unpaid invoices from suppliers for goods or services already received.
Credit card debt – Balances owed on business credit cards.
Wages owed – Salaries and wages that are due but haven’t yet been paid to employees.
Taxes payable – Outstanding amounts owed to HMRC for VAT, Corporation Tax, PAYE, or National Insurance.
Rent and utilities payable – Bills for premises or services that have been received but not yet settled.
Pre-sold goods or services – Money received in advance (deferred revenue) for a product or service not yet delivered.
Accrued expenses – Costs that have been incurred but not yet invoiced or paid (like utility bills or interest).
How can a business reduce its liabilities?
While some level of borrowing is often necessary for businesses in order to grow or invest, too much debt can cause issues with cash flow and your limits. To help stave off any potential problems, it can pay to reduce your liabilities.
One of the most effective ways to do this is to pay off debts sooner rather than later. In particular, prioritise high-interest loans or credit card balances, which can lower the total amount owed over time by reducing the interest that accrues.
Likewise, you can also cut back on any unnecessary expenses. For example, if you have unneeded subscriptions or excess inventory that’s simply taking up space, eliminating this waste will lower the amount you owe.
It’s also important not to take on any new debt or expenditures, where possible, if you feel your liabilities are becoming too high. Borrowing is great in supporting business growth but it’s not ideal if it just covers short-term gaps.
How to manage liabilities in cash flow
Managing liabilities as part of your cash flow strategy is all about timing and visibility. It’s important to know what you owe, when payments are due, and how those outgoings line up with your incoming revenue.
There are some key ways that you can track your liabilities as part of a wider cash flow strategy. These include:
Use forecasts to plan for loan payments, bills, and supplier invoices.
Time your outgoings to follow your major sources of cash inflow.
Maintain reserves to cover unexpected costs or payment delays.
Talk to lenders or suppliers about more flexible repayment options.
Use software tools to stay on top of due dates and avoid missed payments.
And when it comes to using software to stay on top of your cash flow, there’s nowhere better to start than QuickBooks.
Take control of your liabilities with QuickBooks
QuickBooks gives you the tools to master your cash flow and make confident decisions for your business’s future. With real-time insights, you’ll always know where you stand, whether you’re tracking invoices, paying bills, or managing day-to-day expenses.
What’s more, our cash flow software helps you forecast up to 24 months ahead, so you can plan with clarity and respond to challenges before they arise.
Explore plans and pricing to get started.
The information on this website is provided free of charge and is intended to be helpful to a wide range of businesses. Because of its general nature the information cannot be taken as comprehensive and they do not constitute and should never be used as a substitute for legal, accounting, tax or professional advice. We cannot guarantee that the information applies to the individual circumstances of your business. Despite our best efforts it is possible that some information may be out of date. Any reliance you place on information found on this site or linked to on other websites will be at your own risk.
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