What are liabilities?
Liabilities are amounts a business owes to other people or organisations, such as suppliers, HMRC, banks and its own directors, that it will have to pay in future.
What liabilities mean
A liability is an obligation to pay money or provide something in the future because of something that has already happened. On the balance sheet they sit opposite assets, and the difference between the two is equity.
UK accounts split them into two groups:
- Current liabilities, due within 12 months: trade creditors, VAT, PAYE, Corporation Tax, credit cards, overdrafts, accrued costs and the next year's loan repayments
- Long-term liabilities, due after 12 months: the rest of a bank loan, hire purchase, and director's loans the company will not repay within the year
Example
A small marketing agency's liabilities at its year end:
| Liability | Amount | Type |
|---|---|---|
| Supplier invoices unpaid | £6,200 | Current |
| VAT for the last quarter | £7,800 | Current |
| PAYE and NI for March | £2,100 | Current |
| Corporation Tax for the year | £9,500 | Current |
| Bank loan, due within a year | £4,000 | Current |
| Bank loan, due after a year | £12,000 | Long-term |
| Total | £41,600 |
Why they matter for your business
Current liabilities have to be paid from current assets. Compare the two and you can see whether bills due in the next year are covered, which is the basis of the current ratio and working capital. A business that keeps the VAT and tax money it collects in its main account can easily spend it and find the quarter's VAT bill uncovered.
Some liabilities are less obvious. Holiday pay owed to staff, a Corporation Tax bill not due until nine months after the year end, and money owed to a director all count, and leaving them out flatters the accounts.
Liabilities vs expenses
An expense is a cost in the profit and loss account. A liability is an amount still owed on the balance sheet. A £500 electricity bill received but not yet paid is both: an expense this month, and a liability until you pay it.
Provisions and contingent liabilities
Some liabilities are uncertain. If you probably owe something but the amount is an estimate, such as a warranty claim or a dilapidations bill when a lease ends, the accounts include a provision. If it is only possible, for example a customer threatening to sue, it is disclosed in a note rather than included in the figures.
Common questions
If the company owes the director money, yes: it is a liability, usually current. If the director owes the company money, it is an asset of the company, and an overdrawn balance left unpaid nine months after the year end triggers an S455 tax charge.
Yes. VAT charged on sales is owed to HMRC and sits as a current liability until the return is paid. If you reclaim more than you charge, the balance becomes an asset: money HMRC owes you.