If you’re a business owner, there is a need for you to know what liabilities are and how they affect your balance sheet if not properly calculated. Since these liabilities include debts, loans, prospective buyouts, staff pay, you should know how to calculate them as total liabilities.
Because these liabilities are the debts a company owes third parties, the greater they are, the more money your company or business will need to pay off its debts to make a profit.
To know how to do a proper calculation for the liabilities, read through this article.
What are Liabilities?
Liabilities are the debts and other obligations owed by a business in the short and long term. They include:
- Rent
- Utilities
- Payroll
- Loans
- Debt on a credit card
- Accounts receivable
When calculating what debts are short and long-term, it is important to note all obligations and, the figures alongside assets and equity help to illustrate how reliable your business operations are. If they are stable enough, you can attract angel investors.
Why are Liabilities Important to Businesses?
It’s critical for a business to understand its obligations at all times in order to have an accurate picture of its debts. A corporation can design a more realistic budget by considering both short- and long-term liabilities.
It can also assist business decision-makers to determine whether or not they can take out another loan or adjust various strategies in order to save money or work on earning more.
Another key application of liabilities is in determining the owner’s equity in the company. This is an example of an equation:
- Assets – liabilities = owner’s equity
You can also think of the calculation this way:
- Liabilities + Owner’s Equity = Assets
This equation might help employees gain a better understanding of the company. It can also be used to verify the numbers involved, because if the equation doesn’t work (one side’s values are inaccurate), it’s possible that the information or computation is erroneous.
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What is a Single-Step Income Statement?
A single-step income statement is a document that provides a quick overview of a business’s revenue and expenses. It summarizes the revenue, expenses, and bottom-line net income of a corporation in the simplest way possible.
The top of the statement sums all income and gains while the bottom sums all expenses and losses. The simpler approach it takes, the easier it makes record-keeping for investors who would read the financial accounts.
To assess a company’s overall viability as a shareholder, the only place you need to take a critical look at is the net income figure.
In a single-step income statement, the equation is:
(Revenues + Gains) – (Expenses + Losses) = Net Income
What is a Multi-step Income Statement?
A multi-step income statement contains much of the same general information as a single-step income statement, but it calculates the company’s net income, or profit, using many equations.
Operational revenues and operating expenses are separated from non-operating revenues and expenses in the multi-step income statement. This distinguishes between income and expenses that are directly related to the business’s activities and those that are not.
The net income is calculated using three separate accounting methods in the multi-step income statement:
- Gross profit is calculated as net sales – the cost of goods sold. Net sales are reduced by the cost of items sold. The gross profit is calculated because of this.
- Gross Profit – Operating Expenses = Operating Income
The gross profit is deducted from operating expenses. This is where you get your operating income. - Operating Income + Non-operating Items = Net Income
Net non-operating revenues, profits, costs, and losses are added to operational income. This final figure represents the company’s net profit or loss for the reporting period.
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Single-step vs Multi-step Income Statement
In a bid to know how to calculate liabilities, we’ll compare both income statements and see how they can help you calculate liabilities.
A single-step income statement accounts for a business’s net income in a straightforward manner, but a multi-step income statement accounts for net income in three steps, separating from non-operational revenues and expenses.
Benefits of Single-Step Income Statement
- Single-step income statements take less time and effort to prepare since it needs fewer computations
- The single-step income statement is simple and straightforward concentrating on the bottom line, net income. Hence, it’s simple to calculate how well the company is doing financially and at a glance.
Drawbacks
- Single-step income statements may be too sparse in terms of information for some investors. The lack of gross margin and operating margin data can make determining the source of most expenses difficult, and predicting whether a company will remain profitable.
- Investors may be less reluctant to invest in a firm without this information, allowing organizations to miss out on opportunities to raise operating money.
Benefits of Multi-Step Income Statement
- Provides an itemized breakdown of a company’s revenue and expenses, categorized by operational and non-operational revenue making it easy to understand a company’s financial health.
- Reports gross profits: Gross profit is an important indicator because it shows how well a company generates income by using labor and resources
- Reports operating income: It gives an insight into how effectively a company produces a profit from its major business activities.
Drawbacks
- Multi-step income statements can be labor-intensive for accounting teams to prepare due to the granularity involved in collecting excess data.
- Any blunder could lead to investors making incorrect assumptions about the company, resulting in a detrimental impact on the business.
How to Calculate Liabilities
To calculate liabilities, you must follow the process below.
#1. Organize Liabilities
Obtain all necessary information and arrange your accounting data so that you can see the liabilities you need to account for.
Label each liability as you go through this process. If you want to further categorize your liabilities, you can change the labels afterward.
#2. Sort your Liabilities into Short and Long-term
Defining your current obligations allows you to identify what debts you’ll have to pay in no distant time while recognizing your long-term liabilities allows you to prepare for the future of your company.
You may also include other liabilities category for items such as loans between companies with the same owners.
#3. Use Software to Calculate Totals
Using software to calculate totals is generally beneficial, whether you use spreadsheet software or something more advanced.
If your business uses accounting software for day-to-day operations, it’s possible that it’s keeping track of your liabilities and can automate some of these tasks.
#4. Make Sure your Math is Correct
There are several techniques to double-check your math, and it’s a good idea to try all of them just to be sure. You can also use the asset, liability, and equity formulae to double-check that the math is right.
Check your numbers again if one side of the equation does not match the other side.
How to Calculate Total Debt
Total liabilities refer to the total amount of debt owed by your company and according to the Houston Chronicle, you can calculate your small business’s overall debt by following the steps below.
- Find out what your company’s liabilities are.
- Fill in the blanks on your balance sheet with all of your liabilities.
- Add all of your liabilities, both short and long-term
Conclusion
The entire liabilities of a company are all of its debts and financial obligations. It’s critical to understand how to calculate total liabilities in order to assess the company’s net worth. Calculating total liability also allows you to figure out how much money a company needs to be profitable.
References
- https://www.indeed.com/career-advice/career-development/how-to-calculate-liabilities
- https://www.skynova.com/learn/accounting/how-to-calculate-liabilities
- https://www.investopedia.com/ask/answers/102714/what-are-main-differences-between-single-step-and-multiple-step-income-statements.asp
- https://www.freshbooks.com/hub/accounting/single-step-vs-multi-step-income-statement
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