The term “liability” typically has a negative connotation, but from a financial point of view, liabilities are a necessary part of growing and operating any business.
In fact, one of the most important tasks when running a small business is understanding how to record and manage your assets and liabilities. Regardless of industry, healthy companies should have more assets than liabilities to maintain the liquidity necessary for current operations as well as future initiatives. Companies that have more liabilities than assets are operating at a loss.
You can find your liabilities on your company’s balance sheet, one of the four basic financial statements that indicate how a company is performing. The appropriate level of liabilities for a company will depend on many factors, including its industry, maturity, equity levels, risk appetite, and current cash flow. A company with too many liabilities relative to its assets may have trouble keeping up with vendor payments or other financial obligations.
Having insight into your company’s liabilities can help you understand the value of your company and figure out other important ratios such as debt-to-equity or working capital. Such calculations are an important part of financial planning & analysis (), which takes a holistic view of company finances to better support the company’s efforts to meet its operational and revenue goals.
What are liabilities?
Liabilities are any measurable obligations of a company that will require a financial payout that the company has not yet made. These include day-to-day obligations to business partners and employees as well as debt taken on to finance the organization.
How to calculate liabilities
The steps to calculate your liabilities are:
- List your liabilities
- Include liabilities on your balance sheet
- Add up your liabilities
- Check your work with the accounting formula
Here's a look at the process step-by-step:
1. List your liabilities
To start calculating your liabilities, you first need to know which types you have.
There are several types of liabilities that appear on a company’s balance sheet. Usually, larger companies have moreliability categories than smaller businesses.
Long-term liabilities
Long-term liabilities, also called non-current liabilities, are any obligations with payments that extend for more than a year. These liabilities are one factor that lenders consider when determining a business's creditworthiness.
Examples of long-term liabilities include:
- Bonds payable: These are debt securities issued by a company to investors, promising to pay a specified amount of interest over a set period and repay the principal at maturity.
- Mortgages: Long-term loans specifically for purchasing property, where the property itself serves as collateral until the loan is fully repaid.
- Deferred tax liabilities: Taxes that are incurred but not yet paid, often due to timing differences in recognizing income or expenses for tax and accounting purposes.
- Deferred compensation: Compensation that employees will receive in the future for services rendered currently, like pensions or stock options.
- Pension liabilities: Obligations a company has to pay its employees' pension benefits in the future.
- Notes payable: Notes payable are long-term debts that a company owes to financial institutions like banks or other sources of funding like friends and family.
Short-termliabilities
Short-term liabilities, or current liabilities, are short-term debts that a company will need to repay within a year.
Examples of short-term liabilities include:
- Accounts payable
- Payroll
- Dividends payable
- Taxes owed
- Lease payments
- Utilities
- Credit card debt
- Insurance premiums
- Unearned revenue
Contingent liabilities
Some company balance sheets also have a section that includes “contingent liabilities” or those obligations that a company may or may not owe depending on external factors. Pending lawsuits are an example of a contingent liabilitysince the company’s obligation will depend on the verdict.
2. Include liabilities on your balance sheet
You should include your liabilities under their own section of the balance sheet, below the "Assets" section, and above the "Owner's Equity" section.
Mostbalance sheets break down liabilities into individual items, listed under the headings “Current Liabilities” and “Long-Term Liabilities.” To the right of each item, your balance sheet will show the value of that liability, adding up to a “Total Liabilities” number.
The assets section of a balance sheet typically also breaks down into long-term and short-term sections. These include both liquid assets, or those that a company can easily convert into cash, and non-liquid assets, such as real estate. Companies pay for current liabilities using current assets.
The difference between total assets and total liabilities is the value of the owner’s equity, which typically appears at the bottom of a balance sheet. Keep in mind that a balance sheet captures the financial picture of your company at one point in time. Any change in the value of assets or liabilities on the balance sheet can impact the value of equity. By comparison, a company income statement, or profit and loss statement, shows how revenues and expenses have changed over time.
3. Add up your liabilities
Tocalculate your liabilities, simply list out the amount that your company owes across all of its obligations (both current and future) and add them together. This may require gathering up bills, loan documents, and other important paperwork.
For example, if Company ABC owes the following:
Then the company will need to pay $1.7 million to remain current on its liabilities this year.
To determine your total liabilities, add together your short-term liabilities. In the example above, $20.8 million + $1.7 million = $21.5 million. So company ABC’s total liabilities are $21.5 million. If you use accounting software, it'll typically calculate your liabilities for you, as long as you keep the system updated.
Using the accounting formula above, you can subtract your total liabilities from your total assets. This will tell you the value of your total equity. You can use this information to determine your equity multiplier ratio, which is a financial leverage ratio that indicates to what degree shareholder equity funds assets.
4. Check your work with the accounting formula
Liabilities are one component of the accounting equation used to build a balance sheet. In double-entry accounting, you can use the following formula to check if your books add up.
Liabilities + Equity = Assets
Equity refers to a company's assets minus their debts. Assets are items of financial value, like cash or stocks.
How to calculate total liabilities
"Total liabilities" reflects the sum of short-term and long-term liabilities (and contingent liabilities, if applicable). This is the figure that shows how much your company owes on obligations both now and in the future.
Tocalculate your total liabilities, simply add up all of the short-term and long-term debts listed on your balance sheet.
How to calculate current liabilities
To calculate current liabilities, add together all of your short-term liabilities that you owe to lenders within the next year or less.
Current liabilities include payments due on customer deposits and long-term loans (like equipment loans). Other examples include employee salaries, interest payable, and money you owe to vendors and suppliers.
Look at your balance sheet to find the amount owed for each short-term liability for the accounting period you're looking at (whether it be this year, quarter, or month) and sum up the total to find your total current liabilities.
What is the purpose of calculating liabilities?
A company’s liability level is one of the basic metrics that stakeholders use to understand the value and prospects for the business. It’s so important that public companies must include their balance sheet, which includes a breakdown of liabilities in the annual report that they file with the Securities and Exchange Commission (SEC).
Business leaders need a solid understanding of their current and future liabilities to properly gauge the financial health of the organization. For companies that need additional capital, their liability levels may be a key factor considered by both potential investors and lenders involved in the underwriting process if the company wants to borrow money.
If you ever decide to sell your business, potential acquirers will look at its liability levels as one factor in the company’s valuation.
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By providing detailed insights and real-time data, Ramp simplifies the process of tracking and managingliabilities. Whether it's short-term obligations like payroll and accounts payable or long-term commitments such as bonds and mortgages, Ramp offers a streamlined approach to guarantee that these financial responsibilities are met on time.
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