It’s that time again—the time of the year to switch gears and start thinking about the accounting aspects of your business. Whether it’s pulling together your balance sheet or organizing your income statement, you’ll likely stumble across some questions. As you organize your financials, you may wonder, “Are expenses liabilities?”
As a small business owner, there’s a good chance you’re wearing several hats at once. One day, you’re the marketer, and the next, you’re the accountant. Staying on top of your financial statements is just one crucial aspect of your operations, but it will help you know your business inside and out.
You may handle your balance sheet, income statements and cash-flow statements yourself or outsource the duties to an accountant, but regardless, you’ll want to understand how each of these work. Today, we’ll dive into the different account types you need to know and what goes into each.
Specifically, we’ll cover expenses and liabilities and go over what makes these two different from each other.
Five types of accounts
There are five types of accounts that show up on both your balance sheet and income statement. They consist of assets, liabilities, equity, revenue and expenses.
An asset is anything that your company owns that can be converted to cash or has the capacity to generate revenue. They include tangible and intangible things of value gained through the company’s ongoing transactions.
Assets come in all shapes and sizes. There are tangible assets—like cash, property or equipment. And then there are intangible assets—like prepaid expenses, accounts receivable or patents.
Liabilities are what your company owes other parties. They’re what you’re obligated to pay either in the near future or further down the road. You can pay off liabilities with cash or through the transfer of goods and services.
Like assets, liabilities come in several forms. The most common types of liabilities are accounts payable and loans payable. Wages payable, interest payable and unearned revenue are also liabilities.
Equity is the portion of your company that shareholders—including yourself—own. Think of stockholders’ equity as the assets that you as a small business owner and other shareholders fully own.
One example is stocks, including common stock and preferred stock. There are also other types of equity, such as paid-in capital and retained earnings.
Revenue is the money your business makes in exchange for your goods or services. It includes the money you receive from customers as well as interest from your company’s investments.
It’s one of the key components in determining your business’s net income. Your net income is simply your revenue minus your expenses.
Business expenses are what your company pays for on a monthly basis. They consist of the expenditures you have to pay to keep your business operating on a day-to-day basis.
Expenses are temporary expenditures and will reset each accounting period. Examples of expenses you’re familiar with are office supplies, monthly POS system fees or food expenses for your staff.
You may be thinking that expenses and liabilities sound similar, but in fact, they’re quite different.
Are expenses liabilities?
While expenses and liabilities may seem as though they’re interchangeable terms, they aren’t. Expenses are what your company pays on a monthly basis to fund operations. Liabilities, on the other hand, are the obligations and debts owed to other parties.
In a way, expenses are a subset of your liabilities but are used differently to track the financial health of your business. Paying expenses immediately keeps your business afloat. Your balance sheet reflects business expenses by drawing down your cash account or increasing accounts payable.
Expenses are more immediate in nature, and you pay them on a regular basis. They’re then shown on your monthly income statement to determine your company’s net income.
When you don’t pay for an expense, it becomes a liability. Say for instance you can’t afford to pay cash to purchase your monthly office supplies. You decide to take out a loan to pay for these expenses, which then becomes a liability. However, you’ll still continue to track expenses on a monthly basis on your company’s income statement to determine net income.
Let’s take a closer look at how expenses differ from liabilities.
Differences between expenses and liabilities
There are two main differences between expenses and liabilities. First, expenses are shown on the income statement while liabilities are shown on the balance sheet. Second, expenses and liabilities diverge when it comes to payment and accrual of each.
Balance sheet vs. income statement
One of the main differences between expenses and liabilities are how they’re used to track the financial health of your business. Expenses show on your income statement to offset revenue. Liabilities show up on the balance sheet and offset assets.
The income statement is used to report your company’s financial performance for a given period of time, typically over the span of one quarter. It shows your company’s profit and loss and calculates your net income. Your expenses, along with revenue, gains and losses, determine your net income for that period.
The balance sheet is a broader view of what your company owns and what it owes to others. It paints a clear picture of how your company is managing your assets and liabilities to generate revenue, which you’ll see on your income statements. Liabilities are one of the core components of your balance sheet. They offset your total assets with the following accounting equation:
Assets = Liabilities + Equity
But remember, expenses are reflected on your balance sheet in two ways. They can increase a liability account like accounts payable or drawdown an asset account like cash.
Accrual and payment
You accrue liabilities and then pay them off at a later date. You pay off expenses in real-time because they’re necessary for ongoing business operations.
Expenses fund your daily business operations and contribute to turning a profit. When you don’t pay off an expense immediately, it then becomes a liability on the balance sheet.
You incur liabilities and then pay them off at a later date. These are longer-term obligations, though they can be current liabilities or long-term liabilities. A current liability is one that is paid off within one year. A long-term liability is typically a larger sum that requires multiple years to pay down.
Liabilities finance your business and pay for large expenditures. Common examples include equipment, machinery or property. If you don’t pay a liability, you will essentially default on the loan or obligation. For example, if you don’t pay off a loan from a bank or supplier, then you default, which could lead to legal action.
Example of expenses vs. liabilities
Expenses and liabilities are part of your ongoing business operations. Let’s go over a few examples to give you a better idea of the difference between the two.
Let’s say that you pay for one of your employees to fly somewhere to meet a supplier in person. This trip would entail paying for a flight, lodging and meals. These are considered expenses that you pay to help grow your business operations and increase revenue.
Other business expenses you’re likely familiar with are marketing expenses. This can include any advertising, like email marketing, online ads or public relations fees. Your monthly credit card processing and point of sales system fees can also be pooled into your business expenses.
Taking a step back, liabilities are less about day-to-day spending and more about what your company owes. This includes any outstanding loans your business has or money that you owe to suppliers. Liabilities can also include wages you owe to your employees, among other things.
Just remember, your income statement shows your expenses while your balance sheet shows liabilities.
Accounting duties made easy
Knowing the difference between your ongoing business expenses and your liabilities is crucial to effectively manage your company’s finances. You should now have no problem filling out your company’s income statement and balance sheet.
It’s important to stay on top of these financial statements so your business can grow. Think of them as tools to help you uncover areas where you can cut costs and increase profits. You can also optimize management practices and compare your business with your competitors.
KEEP READING: Is Cash an Asset? How to Organize Your Balance Sheet