Liability definition can be multifaceted in the business world. Broadly speaking, a liability can be anything that your company takes responsibility for. The term liability may commonly be used to describe a company’s legal obligation or risk. For instance, businesses will often take out public liability insurance to insulate themselves from legal risk if a member of the public injures themselves on their premises.
In accounting terms, however, a liability refers to cash or other assets that your company owes to another entity. This may be a vendor, finance provider, or even an individual person such as a member of staff. In a company’s business accounts, liabilities will be logged on the right-hand side of the balance sheet in opposition to the company’s assets.
A liability can be a monetary sum that a company will pay to another entity, or it may be paid in goods or services. Balancing assets and liabilities enables businesses to maintain healthy free cash flow and cover their operational expenses.
Examples of liability
Now we know the definition of a liability. But what does it look like in the context of your company? Businesses encounter all sorts of liabilities in the course of their operations. However, these are typically divided into two categories.
Current liabilities are short-term obligations that a company will usually be expected to pay within a year.
Common examples of current liabilities include:
- employee wages
- short-term loans
- bank overdrafts and charges
- accounts payable (money owed to vendors and suppliers)
- customer deposits
- liabilities of discontinued operations (such as products that have been discontinued or departments that have shut down)
Although long-term debts are not counted among current liabilities, the interest and maturities on long-term debts are.
Non-current or long-term liabilities are those that are expected to extend beyond the foreseeable future. If it will take more than 12 months to settle, it is most likely classed as a non-current liability.
Long-term debts like mortgages and finance agreements for vehicles and plant are the most common forms of non-current liability. Others include:
- retirement benefits for employees
- liabilities on product warranties
- long-term lease obligations on vehicles or plant
Are liabilities the same as expenses?
Expenses may technically be classed as liabilities. Many operational expenses (OpEX) will be listed among a company’s current liabilities, while capital expenditures (CapEX) will be listed among non-current liabilities. That said, the two terms are not interchangeable.
Expenses are the costs associated with doing business. They are used to calculate net income by deducting them from revenues. They are listed on the company’s income statements while liabilities and assets are listed on the balance sheet. When expenses are deferred or paid for with credit, this is when they become liabilities.
Frequently asked questions about liability
What are current liabilities?
Current liabilities are short-term financial obligations that are usually expected to be repaid within 12 months, such as accounts payable to vendors and suppliers. If a liability takes longer than this to settle, it is classed as a non-current or long-term liability.
What are contingent liabilities?
A contingent liability is one that may or may not occur depending on the outcome of an event in the future. Product recalls, warranties, and unused gift cards or credit notes are all examples of contingent liabilities. However, the most common example is an unresolved lawsuit or threat of legal action.
How is liability used to calculate equity?
Owner’s equity describes how much of the business the company actually owns (assets) and how much it owes to other entities (liabilities). By deducting a company’s liabilities from its assets, a company can calculate its equity.