Liabilities and Bills Payable25/07/2020
A liability is a financial obligation of a company that results in the company’s future sacrifices of economic benefits to other entities or businesses. A liability can be an alternative to equity as a source of a company’s financing. Moreover, some liabilities, such as accounts payable or income taxes payable, are essential parts of day-to-day business operations.
Liabilities can help companies organize successful business operations and accelerate value creation. However, poor management of liabilities may result in significant negative consequences, such as a decline in financial performance or, worse, bankruptcy.
Current Liabilities vs. Long-term Liabilities
The primary classification of liabilities is according to their due date. The classification is critical to the company’s management of its financial obligations.
Current liabilities are those that are due within a year. These primarily occur as part of regular business operations. Due to the short-term nature of these financial obligations, they should be managed with consideration of the company’s liquidity. Liquidity is frequently determined as a ratio between current assets and current liabilities. The most common current liabilities are:
- Accounts payable: These are the unpaid bills to the company’s vendors. Generally, accounts payable are the largest current liability for most businesses.
- Interest payable: Interest expenses that have already occurred but have not been paid. Interest payable should not be confused with the interest expenses. Unlike interest payable, interest expenses are expenses that have already been incurred and paid. Therefore, interest expenses are reported on the income statement, while interest payable is recorded on the balance sheet.
- Income taxes payable: The income tax amount owed by a company to the government. The tax amount owed must be payable within one year. Otherwise, the tax owed must be classified as a long-term liability.
- Bank account overdrafts: A type of short-term loan provided by a bank when the payment is processed with insufficient funds available in the bank account.
- Accrued expenses: Expenses that have incurred but no supporting documentation (e.g., invoice) has been received or issued.
- Short-term loans: Loans with a maturity of one year or less.
A bill payable is a document which shows the amount owed for goods or services received on credit (meaning not paid at the time that the goods or services were received). The provider of the goods or services is referred to as the supplier or vendor. Hence, a bill payable is also known as an unpaid vendor invoice.
Examples of Bills Payable
Examples of a bill payable include a monthly telephone bill, the monthly bill for the electricity used, a bill for repairs that were completed, the bill for merchandise purchased by a retailer on credit, etc.
In the context of personal finance and small business accounting, bills payable are liabilities such as utility bills. They are recorded as accounts payable and listed as current liabilities on a balance sheet.
The term “bills payable” is often used interchangeably with the term “accounts payable.” As such, a company will treat bills payable in the same manner as it treats accounts payable obligations that will become due within one year. The account for bills payable includes purchases a company makes on credit and money a company borrows that must be repaid within one year.
The bills payable account appears on a company’s balance sheet, which indicates the financial position of the business at a specific point in time. Bills payable reduces the amount of equity owners have invested in the business because owners’ equity equals the remaining portion after liabilities are subtracted from assets. Increased liabilities means the company has less equity. A credit in the bills payable account increases the amount of the obligation the company must pay, while a debit to bills payable reduces the amount of the liability.
If a company takes out a loan, it may be classified as a bill payable if the loan must be repaid within one year. Typically, a loan due in over one year is classified under notes payable, while short-term loans are classified as accounts or bills payable. The company makes interest payments as a result of the short-term borrowing, and the interest due is classified as interest payable until the company makes a cash payment for the amount of interest due. Interest payable is another short-term liability that indicates the company has an obligation to make an interest payment.