What are liabilities?

Definition

Liabilities are the amounts a business still has to pay to other people. On the books, they are claims against the business, not expenses and not owner's equity.

They live as a group of accounts on the Balance Sheet, not as one line. The group includes current liabilities due this year and longer-term amounts due later.

Cash-basis books often show fewer of these lines, because many costs wait until payment. Accrual books record the owe when it arises, even if cash has not left the bank.

This section is what you owe, not what you spent. The related expense, or the asset you bought, was recorded when you incurred the cost.

Where it shows up

Balance Sheet: Located below assets and above equity.

P&L: Related to expenses that create new amounts owed.

Cash flow: Increases in this section, reported cash from operating activities increases.

See also: Balance Sheet · Current Liabilities · Long-Term Liabilities

When you look at your Balance Sheet, this section sits below assets and above equity. The section total is the sum of every amount owed, short-term and longer-term.

When the total is high, it usually means more bills, loans, payroll, or customer deposits are still open. When the total is low, it usually means you have paid those amounts down, or you run with little credit.

The profit and loss statement does not list this section as a line. Related costs already hit the P&L when they were incurred.

On the Statement of Cash Flows, an unpaid operating cost is the typical event behind the strip. This section rises, and reported cash from operating activities rises with it.

How it works

An amount gets into this section when you owe someone and have not settled yet. Buying on vendor credit, drawing a loan, running payroll, or taking a customer deposit can all raise the total.

Accounts payable is unpaid vendor invoices. Notes payable are formal loan balances owed to a bank or other lender.

Accrued liabilities are costs you already incurred whose bill has not arrived. Payroll, sales tax, and credit cards often sit here too.

Current lines are due within twelve months. Longer-term lines are due after that, except for the slice of a long loan that is due this year, which belongs with the current group.

Equity is what is left for owners after you subtract this section from assets. A liability is a claim held by someone else, not by the owners.

When you pay, the specific line drops. Cash falls by the same amount, unless you settle one owe by raising another, such as paying a vendor with a card.

On cash-basis books, some of these lines never appear. You record the cost at payment.

The debt-to-equity ratio compares this section with equity. A rising ratio means more of the business is funded by what you owe.

Example

A temp agency uses a recruiting platform billed $5,000 for the month. The invoice is due in 30 days, and the work is already done.

The agency records:

Debit: Software expense $5,000

Credit: Accounts payable $5,000

Software expense hits the Income Statement, and accounts payable (inside this section) goes up by $5,000. Cash has not moved.

The Balance Sheet is larger on the liability side, and profit is lower by $5,000. Paying later will only settle the owe.

Thirty days later the agency pays the platform:

Debit: Accounts payable $5,000

Credit: Cash $5,000

That payable falls back to zero, and cash falls by $5,000. The expense is not recorded a second time.

Common mix-ups

Liabilities are not expenses. Recording a bill or an accrual raises what you owe; the related cost already hit the P&L, or an asset, when you incurred it.

This section is not the same thing as accounts payable. AP is one line inside the current group; loans, accruals, payroll taxes, and customer deposits sit here too.

Liabilities are not equity. Equity is the owners' residual claim after you subtract what you owe from what you own.

Related terms

• Balance Sheet: A statement showing what a business owns, what it owes, and what is left for owners at a single point in time.
• Current Liabilities: Obligations due within the next twelve months.
• Long-Term Liabilities: Obligations that come due more than a year out.
• Accounts Payable: Amounts the business owes vendors for goods or services already received.
• Accrued Liabilities: Expenses incurred but not yet billed or paid at period end.
• Notes Payable: Formal loan balances owed to a bank or other lender.
• Equity: The owners' residual claim on the business after liabilities are subtracted from assets.
• Debt-To-Equity Ratio: Total debt measured against owner equity.