Unlike assets, liabilities are money or services that your small business owes to another person or entity. Properly documenting and monitoring them can help you plan responsibly for future expenditures and foresee potential risks to your business’s financial security.
As a crucial aspect of financial reporting, liabilities must be broken up into those that are short-term and long-term responsibilities as follows:
These are debts or obligations that must be fulfilled within one calendar or operating year. Typically, short-term liabilities are paid off with cash or liquidated current assets. For example, accounts payable, temporary debt, payroll taxes and current portions of major debt are all liabilities that a small-business owner must find the resources to pay for in the short term.
Keeping up with your small-business’s short-term liabilities allows you the financial freedom to operate out of the black. Minimizing them can also enable you to take on long-term loans that support business growth.
These are debts or obligations that are not due within the calendar or operating year. Many small businesses take on long-term liabilities to fund the basic expenses needed to generate income, including startup costs, equipment, marketing and insurance. Without this option, many small businesses would never have the opportunity to get off the ground.
They can take years to pay off. These debts should always be factored in to predicting your business’s future outlook.
In general, a profitable small business has more assets than liabilities. Therefore, comparing your total liabilities to total assets provides a snapshot of your small business’s financial health. A low liability to asset ratio indicates that your small business is thriving and on-track for future growth, while a high liability to asset ratio signifies financial instability. Because some assets are initially acquired with loans—especially in the case of growing small businesses—it’s also important to consider how your liabilities are being leveraged when comparing them with assets on your balance sheet. For example, liabilities from a piece of machinery that increases production while reducing operational costs is a more meaningful investment than those from purchasing upscale office furniture. In time, a liability that is well managed could end up on the asset side of the balance sheet.
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