How to Calculate Liabilities

Liabilities refer to debts your company has. As a business owner, it's important to know your business's liabilities because they help determine whether your business will experience a profit or a loss. This tells you how well your business is doing financially in the big picture.

Further, differentiating the varied types of liabilities will help you track the money you owe and avoid defaulting on debts. Your company likely has liabilities of some kind, from a formal business loan to wages payable to employees or accounts payable (money you owe your suppliers). Having liabilities is practically inevitable when you're running a business.

Knowing how to differentiate between different types of liabilities and calculate your total liabilities is important for staying on top of your finances as a business owner. This guide gives you the basic information you need.

What Are Total Liabilities?

Total liabilities is an accounting term referring to all the different types of debt and monetary obligations your business owes within a defined period (e.g., a fiscal year or quarter). Total liabilities are calculated and entered into a business's balance sheet.

This total debt figure is also part of the general accounting equation, which serves as a cornerstone of the double-entry accounting method. With this system, a business's balance sheet always remains in equilibrium. Entries on the debit side are covered or have a corresponding entry on the credit side. True to its name, the balance sheet is balanced.

How Do You Calculate Liabilities?

The accounting equation includes three components: assets, liabilities, and shareholders' equity. We've discussed liabilities above. Assets encompass cash and cash equivalents (e.g., certificates of deposit, Treasury bills, and other liquid assets). Shareholders' equity refers to the amount of cash shareholders could collect if the company's assets were liquidated and the company's debts paid.

Here's how the general accounting formula can be used to calculate liabilities:

What Are Examples of Liabilities?

There are many different types of liabilities, from the salaries you pay employees to the income taxes you have to pay the government. All those different liabilities are broadly categorized into two sections: short-term and long-term liabilities. We discuss the differences and provide examples of each type below.

Short-Term Liabilities

Short-term liabilities are those that need to be paid back within one year. Examples of short-term liabilities might include:

• Accounts payable (money you owe to your suppliers)
• Accrued expenses (expenses you haven't yet been invoiced for but technically already owe)
• Short-term notes payable (financing obligations on short-term loans, or "notes payable," that need to be paid in less than a year)
• Unearned revenue (money you've already received for a good or service without actually having provided the good or service)
• Dividends payable (money you owe your shareholders)
• Credit lines (money you've borrowed from a lender (like a bank) that you can access as needed)
• Long-term notes payable (financing obligations on long-term debt or loans, or "notes payable," that you have more than a year to pay)
• Bonds (debt securities that you may have issued to get funding for your business)

Long-Term Liabilities

Long-term liabilities are those that may be paid back in more than one year. Depending on the liability, you might have multiple years to pay it back. Examples of long-term liabilities might include:

A Note About Expenses vs. Liabilities

It's important to note that expenses are not considered part of your company's liabilities. You might assume expenses would automatically fall into this category since they're also a "minus" that takes money away from your business.

However, expenses are differentiated by the fact that they tend to be ongoing payments for goods or services that don't have any financial value - yet contribute to your business's value. Often, expenses are operating costs that help create revenue.

A monthly cell phone bill for your business is a great example. You need your mobile phone to maintain contact with clients, vendors, workers, suppliers, etc. Your business operations, which generate your revenue, require this mobile phone service. However, the mobile phone service itself doesn't have any tangible (monetary) value. You wouldn't be able to liquidate your mobile phone contract or sell it for cash.

How Do You Record Liabilities on a Balance Sheet?

As mentioned, total liabilities are part of the general accounting equation and are recorded on your business balance sheet. As a refresher, here's the general accounting equation:

Your balance sheet is divided into three sections in line with the three components of the general accounting equation: assets, liabilities, and equity. A balance sheet should always live up to its name and be perfectly balanced, meaning the sum of the assets will equal the sum of the equity and liabilities.

When creating a balance sheet, you'll need easy access to your financial data, from money that clients owe you to wages you owe employees and cash you need to pay vendors. Skynova's business accounting software allows you to easily track and manage business financials in one place, simplifying accounting processes like calculating total liabilities and creating balance sheets.

But just what are you supposed to do with all that data? What does a balance sheet even look like — and where do you input your liabilities in your company's balance sheet? Here's an example for a fictional business, Sally's Sweaters, to help clarify your questions.

Let's start with Sally's total current assets. Sally has $5,000 in the bank and another $5,000 worth of accounts receivable expected. She owns $2,000 worth of equipment and $3,000 worth of raw materials. In total, her assets add up to $15,000.

Next, let's look at Sally's total current liabilities. Sally owes $2,500 in accounts payable (her suppliers for high-quality wool and other supplies). She also owes $2,500 in short-term debt for a pricey sewing machine she recently bought on credit. Finally, she owes her assistant $1,000 in wages. Her total liabilities add up to $6,000.

Finally, Sally can record equity on her balance sheet. Sally doesn't have shareholders as she's the sole owner of Sally's Sweaters, so instead of "shareholders' equity" she can simply record "owner's equity."

Now you have Sally's completed balance sheet for Sally's Sweaters, encompassing assets, liabilities, and equity. As you can see, the total assets are equal to the total liabilities and equity. The balance sheet is balanced, just like it should be.

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Notice to the Reader

The content within this article is meant to be used as general information about liabilities and may not apply to your specific situation. Always consult with a professional accountant to ensure you're meeting the relevant accounting standards for your business.