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What is liability?
A liability is what a person or organization owes money on. This includes the obligation to pay taxes, loans, mortgage payments, and invoices for goods and services. Business liabilities include payroll expenses as well as deferred revenues, accrued expenses, and even programs promised to employees or insurance to protect the company’s assets.
When you or your business have unpaid debts, you owe a liability to someone. Personal liabilities only differ from business liabilities in their scope. A claimant must prove the debtor liable in a court of law, after which the claimant can collect on a debt or legal obligation.
Liabilities can result from such actions as negligence or breach of contract, or when a person or business loses a lawsuit. Unpaid bills, taxes, rent, or mortgage payments become liabilities for the payer. If someone is unable to satisfy a liability, a lien may be placed on the person’s property and his assets could be seized. His credit history may be negatively affected and he may be unable to take out a loan.
For a business, all debts payable within the calendar or fiscal year fall under what’s called current liabilities, sometimes referred to as short-term liabilities. Wages and accounts payable, taxes, long-term debt maturing that calendar year, interest payments, and loans are all considered current liabilities. If the company’s current liabilities exceed the amount of cash and liquid assets on hand, the company does not have enough reserves to cover its expenses if an emergency strikes, resulting in possible bankruptcy or closure.
Long-term liabilities include all debts that the business does not need to pay within the next year or operating cycle, such as bonds payable, deferred compensation, income tax, and revenues, health care benefits for retirees, and long-term loans.
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John has gotten lazy about paying his electricity bill every month. After several months of not paying, the utility company shuts off his electricity indefinitely. His only recourse is to pay the unpaid debt, which has become a liability for him, before the company will turn his electricity back on.