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Understanding Liability AccountsBasic Financial Statements – LiabilitiesJust what are liability accounts? What is the correct way to track these? How important are they in the overall scheme of your business?
What Are Liabilities?The liabilities that your company has are the amounts that it owes its creditors. These could be the bank for loans or overdraft. It could be credit card companies. And it is frequently your suppliers. It could also be anyone else you have borrowed money from, such as friends or relatives who helped you get your business going. Why Track Your Business Liabilities?There are some who don’t really bother tracking business liabilities, especially loans to friends or relatives. This is a poor business practise and gives a false picture of your business. It is always a good idea to track all of your liabilities, not only to give an accurate picture of the business, but also to protect those people who are your creditors. Imagine if anything happened to you or your company and your friend or relative had no record themselves of the loan, but your company books did. Say you were in a fatal accident and had no heirs. In this case your company would be liquidated. If you have the loan on your books, at least those close to you are protected and can get some of their money back (assuming there is any after paying back the other higher priority loans). And having these on file shows the true picture of your business. If you structure the loans to relatives and friends properly, then these can improve your financial statements, rather than be a bad thing. How to Enter These in Your BooksWhenever you enter a liability you must enter the amount that was borrowed to the liability account on the balance sheet as well as the opposing side of the transaction. This can differ depending on the type of liability. Most loans give you cash, so they will be entered into the bank account. However, if you are taking credit from a supplier or credit card company, then the opposing side of the entry is going to be entered as an expense, with the appropriate breakdown to the expense and tax accounts. These particular entries will increase the liability. When you make a payment to a liability, you must enter the one side as the payment, decreasing the liability (say you pay your credit card $100), and enter the other side from the bank account (thus decreasing you bank balance by that same $100). Note, if you use an accounting program, then these entries are partially done for you.
The copyright of the article Understanding Liability Accounts in Financial Statements is owned by Johanus Haidner. Permission to republish Understanding Liability Accounts in print or online must be granted by the author in writing.
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