Understanding Liabilities in Accounting: Definition, Types and Examples

Managing business finances is a complex and critical responsibility. While liabilities are a fundamental aspect of a company’s financial health, they are sometimes overlooked or not fully understood, particularly in smaller businesses or those without dedicated financial expertise. Properly managing liabilities is essential for ensuring financial stability and supporting long-term growth.

From loans and unpaid bills to employee salaries and future obligations, liabilities represent your business’s commitments—and failing to manage them can cause cash flow issues, compliance headaches, or even business failure, leaving companies vulnerable in competitive markets.

In fact, 60% of small businesses fail within the first five years due to poor financial planning and debt mismanagement.

In this blog, we’ll break down liabilities in accounting in the simplest terms possible. You’ll learn what liabilities are, their types, how they’re calculated, and how they impact your financial statements.

What Are Liabilities in Accounting?

In accounting, liabilities are debts or obligations a business owes to others. These stem from past transactions and represent commitments the business must settle in the future, often through cash, goods, or services.

Liabilities are a key part of a company’s financial structure, showing how a business funds its operations and growth. They are recorded on a company’s balance sheet under the liabilities section, alongside assets and equity.

The balance sheet must always adhere to the accounting equation: Assets = Liabilities + Equity.

Liabilities are not inherently bad. For example, taking on a loan to invest in equipment or expansion can help a business grow. However, poor liability management can lead to cash flow problems and financial instability.

Understanding what liabilities are is the first step. Next, let’s explore the different types of liabilities and how they are categorised.

Types of Liabilities

Liabilities in accounting are grouped based on how soon they need to be repaid.

Understanding these types is crucial for managing your business's financial commitments effectively.

There are three main types of liabilities: Current liabilities, Non-current liabilities, and Contingent liabilities.

1. Current liabilities

These are short-term obligations that a business must settle within one year. Managing current liabilities effectively is essential to maintaining smooth day-to-day operations.

Examples include:

• Accounts payable: Amounts owed to suppliers for goods or services purchased on credit
• Accrued expenses: Expenses incurred but not yet paid, like salaries or utilities
• Short-term loans: Loans or borrowings that must be repaid within a year
• Unearned revenue: Payments received in advance for goods or services not yet delivered
• Taxes payable: Taxes owed to the government within the current accounting period
• Dividends payable: Profits allocated to shareholders but not yet distributed
• Bank overdrafts: Negative balances that need to be repaid promptly

2. Non-current liabilities

Also known as long-term liabilities, these obligations extend beyond one year. They are typically associated with significant investments or long-term financial strategies.

Examples include:

• Long-term loans: Borrowings with repayment terms exceeding one year
• Bonds payable: Debt securities issued to investors, repayable over time with interest
• Lease obligations: Long-term agreements to use property or equipment
• Deferred tax liabilities: Taxes owed in the future due to timing differences in accounting practices
• Pension obligations: Commitments to pay employee retirement benefits
• Mortgage payable: Loans secured against property, repayable over several years

3. Contingent liabilities

These are potential obligations that depend on the outcome of a future event. They may not occur but must be disclosed in financial statements if they are likely and can be estimated.

Examples include:

• Lawsuits: Potential financial losses from legal cases
• Warranties: Costs of repairing or replacing defective products
• Guarantees: Commitments to cover a third party’s debts if they default
• Regulatory fines: Penalties imposed by government authorities
• Insurance claims: Compensation related to unresolved claims

Impact of Liabilities on Businesses

Liabilities play a crucial role in shaping a business's financial health. Here’s how liabilities can impact a business:

• Cash flow management: Liabilities like loans or credit purchases require regular payments, directly affecting cash flow. Businesses with high liabilities may struggle to cover operational costs or meet unexpected expenses.
• Business growth opportunities: Properly managed liabilities allow businesses to invest in expansion, like acquiring new equipment or opening new locations. However, excessive debt can limit the ability to take on new projects.
• Creditworthiness: High liabilities compared to assets may negatively impact a company’s credit score, making it harder to secure loans or attract investors.
• Operational stability: Unpaid liabilities, such as vendor payments or employee wages, can disrupt operations, damage relationships, and harm a business's reputation.
• Risk of default: Over-reliance on liabilities without adequate revenue to cover repayments can lead to defaults, legal troubles, or even bankruptcy.
• Financial decision-making: Accurate tracking of liabilities provides valuable insights for planning budgets, cutting unnecessary expenses, and improving profitability.

At Alaan, we empower businesses to manage their expenses precisely and easily. Our AI-powered spend management platform provides real-time insights into vendor payments and operational costs, helping you maintain better control over cash flow and liabilities.

By automating approvals and integrating seamlessly with accounting software like Xero and QuickBooks, Alaan ensures accurate liability tracking and timely settlements.

With Alaan, businesses can streamline financial processes and reduce the risk of defaults—paving the way for operational stability and sustainable growth.

Now, to fully understand liabilities, let’s explore a real-world example.

Real-World Example of Liabilities: Samsung Electronics

Understanding liabilities becomes much easier when viewed through a real-world lens. Samsung Electronics is an excellent example, showcasing how liabilities play a crucial role in accounting and business operations.

Samsung's 2021 financial statements clearly show its liabilities, demonstrating their importance in maintaining operational efficiency and driving growth.

Samsung Electronics reported a total liability of ₩121.72 trillion (approximately AED 390.7 billion), divided into current and non-current liabilities.

Current liabilities

These short-term obligations, payable within a year, totaled ₩88.12 trillion (AED 289.2 billion) and included:

• Trade payables: ₩13.45 trillion (AED 44.1 billion), reflecting amounts owed to suppliers for materials and services.
• Short-term borrowings: ₩13.69 trillion (AED 44.9 billion), used for immediate operational needs.
• Accrued expenses: ₩27.93 trillion (AED 91.6 billion), for employee salaries and other recurring costs.
• Provisions: ₩5.37 trillion (AED 17.6 billion), covering potential warranty costs and other obligations.

Non-current liabilities

Long-term obligations amounted to ₩33.60 trillion (AED 110.3 billion) and consisted of:

• Debentures and long-term borrowings: ₩3.37 trillion (AED 11.1 billion), used for large-scale investments like R&D and infrastructure.
• Deferred income tax liabilities: ₩23.20 trillion (AED 76 billion), reflecting taxes owed in the future.
• Long-term provisions: ₩2.31 trillion (AED 7.6 billion), addressing potential long-term liabilities such as employee benefits.

Impact of liabilities

Samsung strategically uses liabilities to fund innovation and expansion while maintaining financial stability. For example:

• Investments in cutting-edge manufacturing facilities are often financed through long-term liabilities, enabling the company to stay competitive in the semiconductor and electronics markets.
• Efficient management of current liabilities ensures smooth daily operations, such as timely supplier payments and inventory procurement.

By balancing its liabilities with solid revenue generation and asset management, Samsung demonstrates how liabilities can be effectively leveraged to achieve business objectives.

How To Calculate Liabilities?

Calculating liabilities in accounting is essential to understanding a company’s financial position. It involves identifying, categorising, and summing up all short-term or long-term obligations. Here's how businesses calculate liabilities step by step:

1. Identify all liabilities

Start by listing every financial obligation the company has incurred, including both current and non-current liabilities. Examples include:

• Accounts payable
• Short-term loans
• Salaries payable
• Long-term debt
• Deferred tax liabilities

2. Use the general ledger

The general ledger is the foundation for tracking liabilities. Ensure that all entries for obligations are updated and accurately recorded.

3. Categorise liabilities

Divide liabilities into categories based on their payment timelines:

• Current liabilities: Obligations due within a year (e.g., accounts payable, short-term loans).
• Non-current liabilities: Obligations due after a year (e.g., bonds payable, long-term loans).

4. Sum up liabilities

After categorising, calculate the total for each category. For example:

• Add up all current liabilities like accounts payable, taxes payable, and accrued expenses.
• Do the same for non-current liabilities, including bonds and deferred taxes.

5. Apply the accounting equation

To ensure accuracy, check that the accounting equation holds:

Assets = Liabilities + Equity

If your liability calculations are correct, then subtracting equity from total assets will match the total liabilities:

Liabilities = Total Assets - Total Equity

Example Calculation

Let’s calculate a company’s total liabilities based on the following:

• Current liabilities:some text
  • Accounts payable: AED 10,000
  • Short-term loans: AED 5,000
  • Salaries payable: AED 3,000
• Non-current liabilities:some text
  • Bonds payable: AED 20,000
  • Deferred tax liabilities: AED 7,000

Step 1: Add current liabilities

AED 10,000 + AED 5,000 + AED 3,000 = AED 18,000

Step 2: Add non-current liabilities

AED 20,000 + AED 7,000 = AED 27,000

Step 3: Calculate total liabilities

AED 18,000 (current) + AED 27,000 (non-current) = AED 45,000

By using this method, businesses can calculate and cross-check their liabilities accurately, ensuring their financial statements remain consistent and reliable.

Now, after understanding how to calculate liabilities, the next step is to explore the financial ratios that use these figures to evaluate a company’s debt management and overall economic health.

The Financial Ratios Involving Liabilities

Financial ratios involving liabilities provide insights into the liquidity, leverage, and overall financial stability of a business.

Below are some of the most commonly used ratios:

1. Debt-to-equity ratio

This ratio measures the proportion of a company’s liabilities to its equity.

A higher ratio indicates greater reliance on borrowed funds, while a lower ratio suggests more conservative financing through equity.

Formula:

Debt-to-equity ratio = Total liabilities ÷ Shareholders’ equity

Example:

If a company has total liabilities of AED 300,000 and equity of AED 500,000, the debt-to-equity ratio is: 300,000 ÷ 500,000 = 0.6

2. Current ratio

The current ratio evaluates a company’s ability to meet short-term obligations with its current assets.

A ratio above 1 indicates that the company has sufficient assets to cover its liabilities.

Formula:

Current ratio = Current assets ÷ Current liabilities

Example:

If a business has AED 200,000 in current assets and AED 100,000 in current liabilities, the ratio is: 200,000 ÷ 100,000 = 2.0

3. Debt ratio

The debt ratio shows the percentage of a company’s assets financed through liabilities.

A lower debt ratio generally reflects better financial stability.

Formula:

Debt ratio = Total liabilities ÷ Total assets

Example:

With AED 400,000 in total liabilities and AED 1,000,000 in assets, the debt ratio is: 400,000 ÷ 1,000,000 = 0.4 (40%)

4. Long-term debt-to-asset ratio

This ratio focuses on how much of a company’s long-term liabilities are financed by its total assets. It’s particularly useful for evaluating the sustainability of long-term debt.

Formula:

Long-term debt-to-asset ratio = Long-term liabilities ÷ Total assets

Example:

For long-term liabilities of AED 250,000 and total assets of AED 1,000,000, the ratio is: 250,000 ÷ 1,000,000 = 0.25 (25%)

5. Times interest earned (TIE) ratio

This ratio measures a company’s ability to cover its interest expenses using its operating income. A higher TIE ratio indicates better financial health.

Formula:

TIE ratio = Operating income ÷ Interest expense

Example:

If a company has an operating income of AED 150,000 and interest expenses of AED 30,000, the ratio is: 150,000 ÷ 30,000 = 5.0

Conclusion

Liabilities are an essential component of a company’s financial framework, offering valuable insights into its commitments, financial health, and growth potential. Effectively managing liabilities isn't just about keeping track of numbers—it’s about ensuring operational stability, improving cash flow, and positioning your business for sustainable growth.

Modern tools and technologies are revolutionising liability management, making it easier than ever for businesses to streamline their processes and make data-driven decisions. At Alaan, we empower businesses with advanced spend management solutions designed to simplify liability tracking and improve financial oversight.

At Alaan, our Corporate Cards offer real-time visibility into team expenses, allowing you to streamline vendor payments and maintain better cash flow control.

With Expense Management, you can set spending limits, automate approvals, and track every payment to ensure timely settlements and reduce the risk of default.

Leveraging AI Automation, Alaan ensures accurate reconciliation, categorisation of liabilities, and seamless integration with accounting platforms like Xero and QuickBooks.

These features give businesses the insights needed to improve creditworthiness, stabilise operations, and make data-driven decisions. With Alaan, managing liabilities becomes simpler, smarter, and more efficient.

Book a free demo today and see how Alaan can help you!