We often come across the question, “Who is liable for this?” Whether a car collided into another or a restaurant still owes their wine merchant for the month’s supply, liabilities often take on various forms. The key here is to understand fully what it is.

In the realm of business, liabilities can end up crippling a company when dealt with improperly. So today, we’re going to help you have a better understanding of what liability is, how it applies to you and how to lessen them.

First off, What is Liability?

Liability is a legal obligation that binds an individual or business to settle a debt. Liabilities often arise throughout the course of the business operations and can occur in numerous ways. It can also be experienced by an individual, who for example, hit someone else’s car and is now liable for the damage.

balance sheet example

Image via Microsoft

In corporate terms, liability is reported on a company’s balance sheet and includes, but is not limited to, accounts payable, loans, taxes, wages, accrued expenses, and deferred revenues.

Just about any business can be liable for something, more so for sole proprietors since there is no shield between you and your company (forming an LLC or C Corp helps provide a “corporate veil” – more on that in another article).

Long-term vs. current liabilities

Businesses often encounter two kinds of liabilities: Current and long-term. Current liabilities are debts that are due within the current year, while long-term liabilities are basically those that will be paid in the future. For example, a bank loan that’s payable for the next 10 years is considered a long-term liability. However, the portion of that long-term loan with payments due in your current fiscal year is considered a current liability.

What’s the Difference Between Liabilities and Assets?

Assets are anything and everything that a company or an individual owns. Some are considered tangible. Examples of tangible assets include buildings, machinery, manpower, equipment and the like.

Intangible assets are items such as patents, goodwill, and intellectual property. Compared to liabilities, which are obligations, assets offer current or future economic benefits to the company.

For an individual, equity in a house may be considered an asset. Offsetting that is the mortgage, which is considered as the person’s liability. To the bank holding a mortgage on the house, the mortgage note is the asset because it brings them financial value.

Here are a few things you need to know about personal liabilities:

Even if you have formed an LLC or Corporation, you are still not completely safe from personal liabilities.

Here are five things you need to keep in mind.

1. A noncompliant business entity means your assets become vulnerable. There are many things you need to do to ensure you are acting as a company and not as an individual. Advice from an experienced business accountant and business attorney are critical to maintaining the protection of what is referred to as the “corporate veil.”

2. Personally guaranteeing a business loan means you are responsible for the debt. The type of loan a business needs is called a “non-recourse loan.”

3. Signing a business contract under your name means you are responsible for the debt. Always be sure to sign as an officer of the company, whichever office you hold (ex. President, CEO, etc.).

4. Mixing personal and business funds pierces the corporate veil. Always keep a business bank account, carefully maintain your books, and never pay personal expenses from the corporate account.

5. If you commit a crime, you can’t hide behind your business structure.

How can you reduce liabilities?

There are various ways you can reduce personal and corporate liabilities. First, you need to carefully track all of your financial activity using Quickbooks or a similar tool, and maintain copies of all receipts, bank statements, etc. Reconcile your bank statements monthly, and keep your personal finances completely separate. Use loans and credit carefully, protecting your cash flow. Last but not least, consider business insurance to add an additional layer of protection.

 

Featured image CC by 2.0, by Mike Lawrence, via Flickr

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