When doing any kind of business, you need to understand that all of your moves will involve some sort of risk. The world is already a vicious place, but adding money into the mix makes it even more dangerous. Whether you are a start-up or an established mega-corporation, there is still a chance that everything could just fall apart.
It is crucial to secure your position while still trying to improve your quality as a company. This is why you need to minimize your liabilities as much as possible, even if you cannot entirely avoid them.
What is liability?
Liability is a word that has been used in the most negative of ways, and for a good reason. It is synonymous with weakness, something that we do not want to be associated with ourselves. However, they are unavoidable because a business without any kind of liability is a sitting duck.
Arguably, it is better for a company to fail due to making “high risk, high reward” decisions than not doing anything at all. Stagnation would just delay the inevitable doom, but it would still be best to accrue liabilities that would end up being beneficial in the end.
Now, what is a liability? It is anything that a company or entity owes to another. As long as this owed “thing” has monetary value, it is considered a liability by the company. It is usually on the right side to symbolize that it is supposed to be deducted from your assets if you are recording. The value that you arrive at after deducting liabilities from assets determines your net worth.
It is important to differentiate this one from expenses, as they can have a similar role. The only difference with the former is that it is needed for the growth of the company. The latter is just something that you need for operational costs.
You can also take this definition quite literally. Think of it as money owed to another institution. Your ability to pay it off can be one of the factors that will determine your influence as a company or business. Some liabilities might take years before they can even be cleared.
Others, though, can be settled within just a few days. It will all depend on the amount and the rules set for paying all of it. This can still reflect on your company’s documents even decades after you started operating, making it one of the most important aspects of any financial record.
There are two types of liabilities: Current and Long-term. These are just divided by the time needed for any person or organization to pay them out—the current ones required to be paid within the year, usually for cash.
A long term liability takes incremental payments, but it is for a better payout. These are also the ones which are valued higher since their impact on the company can be noticeable. Some of the best examples of this kind of liability include pensions and payrolls. It can incur interest depending on what kind of debt you have made as well.
Business Matters Most
Liabilities are paired with assets as they comprise the net worth of a company. It does not mean that you have already failed as an organization if you have tons of liability. Your ability to pay them off will be measured, though, so you need to keep track of these all the time. There are certain cases wherein these parts of the accounting records can be easily manipulated.
You may need to have a competent auditor and accounting experts on your side to keep the books as updated as possible. Developing this system as early as your inception as a company would be beneficial as you grow into a larger institution.
It can be quite complicated to oversee this part of the business. After all, you might be thinking that you are losing some money by looking at all of these. However, as we have mentioned before, this is still vital to the business. It means that you are moving as a company, trying to improve and taking risks for the benefit of your growth.
Even though you are spending all of it now, you need to know where to spend it and why. It can help in paving the road to your successes despite all the payments required to be made. As long as you manage your assets and liabilities and ensure that your accounts don’t fall on the red, you’re going to be okay.
Still, it would be even better if you can make your company profit first. To learn more about this financial model, don’t hesitate to reach out to Annette Ferguson – Chartered Accountant and Certified Profit First Professional – who can help you unlock financial strategies to improve the profitability of your business amidst an economic crisis. Book a call with us. You can also follow us on any of our social media channels and subscribe to our YouTube channel. We’d be more than happy to help!