This is money you owe, or will have to pay in the future, eg PAYE tax due the following month. Tracking liabilities in a balance sheet help you get to know the cost of running your business and the bills heading your way. This puts you in a better position to plan your spending and saving, and spot risks on the horizon.
These types of liabilities are common line items on a balance sheet.
Current liabilities: What you’ll have to pay out within a year, including
- income tax
- salaries
- unused employee leave or holiday pay
- bonuses for employees likely to hit agreed targets
- loan/mortgage instalments for next 12 months. The rest of the loan is listed in non-current liabilities
- unearned, or deferred, revenue — pre-paid orders and other money you are been paid in advance.
Unearned revenue is a liability because you haven’t yet done what you’ve been paid to do, and costs linked to supplying it haven’t yet come out of your pocket. Once the sale is completed, the amount paid is no longer a liability — it’s recorded as revenue on your income statement.
Checking deferred revenue will help you manage cash flow. It also shows potential buyers or investors a fuller picture of your business’s earning potential and sales to be completed.
Accounts payable: Money your business owes for goods or services, eg to a vendor or supplier.
Keep track of these figures to plan your spending, make sure bills are paid, and keep an accurate idea of costs for each job or project. Potential buyers or investors will look at accounts payable to see if your finances are under control.
Non-current liabilities: Money you’ll have to pay out over a number of years, also known as a long-term liability, including:
- Long-term debt, eg loans and mortgages: Total amount borrowed, minus payments for the next 12 months — these are a current liability.
- Long-term leases, eg hire purchase of a vehicle: Total amount borrowed, minus payments for the next 12 months — these are a current liability.
Equity aka the net value of your business
This measures the accumulated money in your business, including money from you or an investor. Positive equity means your assets are worth more than your liabilities. Negative equity means your liabilities outweigh your assets.
These types of equity are common line items on a balance sheet. For small- to medium-sized businesses, equity might be retained earnings alone. For larger businesses, balance sheets tend to include shares and other types of equity. If you have business partners, or an investor who owns part of the business, this is where their stake will show up.
Retained earnings: It’s the cash reserves your business has built up.
Here’s how your balance sheet works it out:
Previous statement’s retained earnings + net income — dividends paid to shareholders = current retained earnings
It’s important to master retained earnings when you want to grow. A positive number means you have money to invest back into your business or pay off debt faster.
Negative retained earnings means your business has built up more losses than income over time — it isn’t earning enough, or is spending too much. Fast-growing businesses might have negative retained earnings. This is OK if it’s planned and for a short time only. If it’s not planned — or becomes a unexpected pattern — it shows you need to look again at how to make your business profitable. It’s a red flag for you, and to any investors or buyers.
Total shareholder equity: Also known as net assets, this is funds contributed by the owner — and any others with a stake in the business — plus retained earnings. Potential investors like to see an owner with equity, commonly called skin in the game, before they agree to put money into a business.
The amount of time between making a sale on credit and receiving payment from the customer is critical information you'll need to track carefully.
Along with managing your accounts receivable by improving your credit and collection techniques, sound cash flow management demands that you keep a sharp eye on your payables and expenses.
Each time you make a purchase from a supplier without paying for it at the time of the purchase, you create an account payable (a payable) for your business. Accounts payable are amounts you owe to your suppliers that are payable sometime within the near future — "near" meaning 30 to 90 days.
Without payables and trade credit you'd have to pay for all goods and services at the time you purchase them.
- The average payable period is the best indicator of your success in managing your cash outflows.
- Our case study shows you how to calculate your average payable period.
- Using your payable period to slow down outflows can significantly improve your cash flow.
- The accounts payable aging schedule gives you a good indication of the amount of cash needed to cover your expenses during the same time period. Using the example schedule above, Fortmann's Hawkeye Haven will need to generate at least $7,750 in income to cover the current month's purchases on account.