The balance sheet explained: Liabilities

This article gives some simple examples of how to break down liabilities on the balance sheet for a UK company. It deals with micro-entity accounts because they are the simplest example. Also, micro-entities are by far the most common company size and the basic principles also apply to other sizes of company.

The balance sheet is part of the annual accounts that all companies must file with Companies House, along with the income statement (profit and loss account).

Liabilities are any debts and other financial obligations a company has at the date of its balance sheet. They must be balanced against assets to show what the company is worth when all its outgoings and debts are accounted for.

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Liabilities can be divided into two categories:

  • Current liabilities: financial obligations that are expected to be settled in the next accounting period (usually the twelve months following the date of the balance sheet)
  • Long-term liabilities: financial obligations that extend into future accounting periods and will take more than twelve months to settle.

Current Liabilities

Current liabilities are short-term in that they are expected to be paid off in full within twelve months. They tend to include the following:

  • Bills and invoices from suppliers – rent, for example
  • Loans: short-term loans and other debts that are due within twelve months
  • Accruals: goods and services the company has used but for which an invoice has not yet been received
  • Deferred income: funds that have been paid to the company for goods and services it has not yet provided
  • Any dividends payable from profits
  • Current portion of long-term debt: that part of a longer-term agreement that falls due within twelve months.

Current liabilities are short-term in that they are expected to be paid off in full within twelve months.

Long-term liabilities

Long-term liabilities are liabilities that are not due for payment in the next twelve months. Typical long-term liabilities for a micro-entity include:

  • Long-term debt: any amounts owed that have a repayment period of more than a year. These can include loans and other forms of borrowing.
  • Deferred tax liabilities: future tax bills that fall due beyond the next twelve-month accounting period
  • Leases on equipment and premises
  • Convertible loan notes: loans from investors that can be converted into equity shares at a future date when the option is exercised
  • Provision for liabilities: an amount set aside for possible future expenses arising from legal obligations, product warranty and refund commitments, and other such liabilities.

Long-term liabilities are liabilities that are not due for payment in the next twelve months.

The total of both current and long-term liabilities is summed to provide the company’s Total Liabilities, which is the amount the company owes to various creditors and stakeholders.

When all liabilities have been added together, the balance sheet subtracts them from net assets to give a figure for shareholder equity: the company’s net worth. This is entered on the balance sheet under Capital and Reserves along with share capital: the nominal value of issued shares. In a micro-entity, share capital is likely to be a token figure like £1 or £100, though it can be any amount.

Micro-entity liabilities examples

Current liabilities

  • Trade creditors: The value of goods and services the company has received but not paid for yet. Example: XYZ Ltd. has received £2,500 worth of inventory or stock from a supplier but has not yet paid for it by the end of the accounting period. This amount should be recorded as a liability under Trade Creditors. The entry might say ‘Amount owed to Supplier A for inventory purchases: £2,500’.
  • Accruals: Expenses the company has incurred but not yet paid for. Example: XYZ Ltd. has incurred £1,500 in salaries and wages for its employees but the payroll won’t be run until after the balance sheet date. The £1,500 in salaries and wages will be recorded as an accrual, for example ‘Accrued salaries and wages: £1,500’.
  • Deferred income: Income received but not yet earned. Example: XYZ Ltd. has received £3,500 from a customer for services and XYZ Ltd. has not yet provided the services. This amount will be recorded as deferred income until the services have been provided, for example ‘Deferred income from Customer B: £3,500’.
  • Loans: The value of loans repayable within a year of the balance sheet date, including any overdrafts and director’s loans. For example, XYZ Ltd. has a bank loan of £9,000 and an overdraft of £2,000. These would be listed under Loans as ‘Bank loan from Bank C: £9,000’ and ‘Overdraft with Bank D: £2,000’.
  • Tax creditors: Tax payments falling due within twelve months, such as Corporation Tax, VAT, PAYE and National Insurance. Example: XYZ Ltd. has a Corporation Tax liability of £4,500. This is listed as such under Tax creditors.

Long-term liabilities

  • Amounts falling due after more than one year: Payments that will fall due more than twelve months after the balance sheet date. For example, a long-term bank loan that is repayable over 3 years.
  • Provision for liabilities: Estimated value of future payments whose date is not yet known with precision. Example: XYZ Ltd. has a two-year warranty on its products. There may be future warranty claims more than twelve months ahead of the balance sheet date. Some money is ‘put aside’ as a liability to cover the expected level of warranty claims.
  • Accruals and deferred income: As under current liabilities, but payable more than twelve months after the balance sheet date. Example: XYZ Ltd. has a service contract with a customer that spans 3 years. XYZ Ltd. has received a prepayment from the customer, part of which is for services that will be delivered after longer than twelve months. That portion of the service fee will be listed under accruals and deferred income.

Once you have added up all your liabilities, subtract them from your assets to give the company’s net worth. In Inform Direct, liabilities should be entered as positive values. The software does the calculation once they have been entered.

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