Liabilities are financial debts or obligations that your business owes to others. This can include credit card debt, loans, unpaid bills, mortgages, or any other financial responsibilities that must be settled in the future.

Understanding liabilities is crucial for managing your business’s financial health. Let’s break down what they are, with examples, below.

Types of Liabilities

Liabilities fall into two main categories: current liabilities and long-term liabilities.

1. Current Liabilities

Current liabilities, also known as short-term liabilities, are short-term debts that must be paid off within one year. They often include...

• Accounts payable (unpaid bills to suppliers)

• Short-term loans

• Credit card balances

• Wages payable (employee salaries not yet paid)

• Taxes owed

2. Long-Term Liabilities

Long-term liabilities are debts that must be paid off in more than one year. They often include...

• Business loans (with repayment periods longer than a year)

• Mortgages on property

• Lease agreements

• Bonds payable

Why Liabilities Matter

Liabilities aren’t inherently bad—they often help businesses grow. Taking on a loan to buy equipment or leasing a space can fuel expansion. However, too much debt can strain cash flow and hurt profitability.

Keeping track of liabilities allows you to...

• Assess your financial health by making sure your liabilities aren't too high relative to your assets. High liabilities vs. assets could signal financial risk.

• Plan repayments to avoid overpaying on interest, align your cash inflows and outflows, and keep your creditors (and your credit score!) happy.

• Improve your creditworthiness by managing debt responsibly, making payments on time, and ensuring that you don't have too much debt relative to your income.

Liabilities vs. Assets

While assets (like cash, inventory, or property) add value to your business, liabilities represent claims against that value. The value could include cash in your bank account, camera gear, art supplies, etc. For small loans, your savings are usually the "collateral" on the loan. For larger loans, your house or even your car could act as collateral (if you choose to use it as collateral!).

The relationship between assets and liabilities is key, and can be represented using what's known as the "Balance Sheet Equation":
Assets = Liabilities + Owner’s Equity. This means what your business owns (assets) is financed either by debt (liabilities) or owner's equity (which is your ownership in your business).

Liabilities are financial debts or obligations that your business owes to others.

Frequently Asked Questions (FAQs)

What are examples of liabilities?

Common examples include loans, credit card balances, unpaid bills from clients or suppliers (accounts payable), mortgages, student loans, car loans, and taxes owed. Liabilities can be short-term (due within a year) or long-term (paid over multiple years).

Are liabilities bad for a business?

Not necessarily! Liabilities like loans or leases can help businesses grow. However, too much debt can strain cash flow. The key is balancing liabilities with assets and income to maintain financial health.

How do liabilities affect a balance sheet?

Liabilities are a core part of the balance sheet equation: Assets = Liabilities + Owner’s Equity. They represent what the business owes, while assets show what it owns. Tracking both ensures accurate financial reporting.

Disclaimer: the information provided in this article is for educational purposes only and does not constitute tax, accounting, investing, legal, or financial advice. The information in this article does not take into account your unique financial or business situation or goals, and YCCPA cannot be responsible for reader's financial decision-making. YCCPA's goal is to educate and support you on your creative business journey.

Written by David Kindness, CPA

David is a CPA (Certified Public Accountant) and professional photographer, videographer, and designer based in San Diego, California. Learn more.

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