Can You Differentiate Debt and Liability?
When you run a business, you need to carry out various activities and transactions, and you need to record them in the financial statements of your company. You may hire an in-house accountant or bookkeeping firm in Singapore to let the experts help you with this if you are not sure about the correct way of preparing those statements. In the financial statements, the accountants will classify the business transactions that arise from various activities under different categories, which include revenues, expenses, assets, liabilities, equity, and so on. Among the terms, “debt” and “liability” might be two terms that people will always get confused.
Most people must have heard of both the terms, and they think that both means the same, that is, they owe money to others. However, there are some slight differences between debts and liabilities. Debts refer to the part of the liabilities arising from the condition where the company raise funds by borrowing money from others. On the contrary, liabilities include all financial obligation that the company owes to others.
Debts are the amount of money the company has borrowed and has to pay back in the future, for example, bank loans. They only arise from borrowing activities. As against, liabilities do not only arise from the borrowing activities but also other activities. As an instance, the accrued wages, which are the payments that the company should pay for its employees, but it has not paid yet, are categorized under liabilities.
Besides, another difference between debt and liability is that the former exists in monetary form, while the latter might not be in the form of money. When business owners borrow money from the investors or banks (Also see Is Opening a Business Bank Account Necessary?) , the amount of money borrowed is classified as the company’s debt. On the contrary, anything which imposes costs on the business falls under the category of liability. Hence, expenses that the company (Also see What is Meant by the Term “Company”?) will incur in the future, such as the payment that the company should pay to its suppliers, as well as the accrued wages are the company’s liability.
Also, business owners can use them to calculate different ratios too. By using the amount of debts, they will be able to calculate the leverage ratios to measure the debt levels of their business (Also see Ways to Alleviate Business Tax Risks). They will be able to assess how dependent their business is on debt. Contrarily, the sum of liabilities helps in the calculation of liquidity ratio. This ratio helps business owners to evaluate their company’s ability to settle its short-term and long-term financial obligations.
In short, the concepts of debt and liability are quite similar to each other. However, keep in mind that there are some dissimilarities between both of them too. Business owners should monitor the levels of debt and liability constantly so that they know the amount of debt their company owes and the financial obligations in the form of liability (Also see Understanding Current Liabilities) that they need to pay in the future.