Accounting: How to easily calculate Liabilities
Why are liabilities important to businesses?
A company should always be aware of its liabilities in order to have a precise understanding of its debts at any given time. Planning for both immediate and long-term liabilities enables a company to create a more precise budget. Additionally, it can assist business decision-makers in determining whether they can or should take out another loan or change different cost-saving or profit-boosting strategies.
Liabilities are also crucial in determining how much ownership equity is held by the company’s owners. This equation can look like this:
Assets – liabilities = owners equity
Another way to look at this calculation is:
Assets = liabilities + owners equity
This equation may improve how employees view the company. Additionally, it can be used to check the accuracy of the numbers because if the equation doesn’t work (i.e., the numbers on one side or the other are incorrect), the data or calculation may be inaccurate.
What are liabilities?
A company’s short- and long-term debts and other obligations are referred to as liabilities. This can include items like:
Liabilities are frequently used by prospective investors, along with other financial data, to decide whether to invest in the business. In addition to using assets and liabilities, accounting professionals perform a straightforward calculation to determine total equity.
Liabilities that will be assessed in a year or less are referred to as short-term or current liabilities. This covers rent for the following year, any loan payments and interest, payroll for the following year, and any sums owed to suppliers or vendors. Unless it is an investment in an asset, anything that a business must pay back in a year or less is considered a current liability. For instance, if a company buys a cell phone, the cost of the phone is an expense, but the monthly cost of the phone is a liability.
Anything a business must pay for in the future that will take more than a year is considered a long-term liability. An example of this would be rent. Rent due over the following 12 months would be considered a short-term liability, but rent due for the remainder of the lease’s term would be considered a long-term liability. Similar to loans, any payments due within the next year would be considered short-term liabilities rather than long-term obligations. Pensions and warranties are also long-term liabilities.
One crucial distinction between liabilities and expenses is that they are. If you pay for materials to make a product up front or buy office furniture, those costs are considered expenses. If the payment is delayed in either of those scenarios, it changes from an expense to a liability. A company’s income statement shows expenses along with revenue, and its balance sheet shows its assets and liabilities.
How to calculate liabilities
These are the steps to assessing the liabilities:
1. Organize liabilities
Gathering all the data you might require is the first step in this process. This entails setting up your accounting information so you can see the liabilities you need to account for. Label each liability number as you proceed with this process, for example:
If you want to further classify your liabilities, you can change the labels later. You might be able to find this information in your history if you use accounting software. Most software also has specific liability categories, so you can complete this step more easily.
2. Sort liabilities into current and long term
Knowing your current liabilities helps you prepare for upcoming debts you must pay, and knowing your long-term liabilities aids in planning for your company’s future beyond the upcoming year. In most balance sheets, it is necessary to separate these two categories for clarity. Loans between companies owned by the same person or entity may occasionally be included in a company’s “other liabilities” category, but short-term and long-term debt is more frequently used.
3. Use software to calculate totals
It’s usually beneficial to use software to calculate your totals, whether you use a spreadsheet or something more complex. If you use accounting software for your regular business operations, it might also track your liabilities and perform some of these tasks automatically.
Ultimately, what you’re doing here is adding up all of your liabilities, both short-term and long-term, and then combining those two figures to determine your total liabilities. Finding all three liabilities is crucial to obtaining a complete picture of your financial situation.
4. Check your math
There are several ways to check your math, and it’s beneficial to use them all to ensure the accuracy of your calculations. First, make sure your numbers for short-term, long-term, and total liabilities are all correct by going through and checking your totals at least once. Then, make sure the math adds up by using the equations for assets, liabilities, and equity. Check your numbers once more if either side of any of those equations does not match the other side.
Example of calculating liabilities
When calculating their total liabilities, Lincoln Florist discovered the following figures:
Payroll: $168,000; Rent: $15,000; Utilities: $5,000; Loans: $16,000; Sales Tax: $3,678; Accounts Payable: $4,072; Credit Card: $1,954
Total short-term liabilities: $213,704
Remainder of lease: $60,000
Remainder of business loan: $140,000
Total long-term liabilities: $239,500
Total liabilities: $453,204
How do you calculate assets to liabilities?
A debt-to-assets ratio is a type of leverage ratio that assesses the relationship between a company’s total assets and its debt obligations, including both short- and long-term debt. Debt-to-Assets Ratio = Total Debt/Total Assets is the formula used to calculate it.
How do you calculate liability with assets and equity?
To calculate the total amount of liabilities, find the total assets and equity on your balance sheet. Liabilities = Assets – Shareholder’s Equity