4 key differences between liabilities and expenses

What’s the difference between a business expense and a business liability? When you’re running a business, chances are you’ll have to deal with both. By having a clear picture of your business’s liabilities and expenses, you’ll have a head start in managing your company’s finances effectively, including financial reporting and planning. There are a few key differences between liabilities and expenses, and knowing what they are can help ensure you’re making smart business decisions—now and in the future.

In this article, we’ll explore the different types of business liabilities and expenses and what sets these two financial concepts apart.

What you’ll learn:

• Liabilities are financial obligations or debts a business owes to an outside party, such as accounts payable, short-term loans and other commitments that require future payment or services. 

• Expenses are the costs associated with running a business and generating revenue, like office supplies, rent and cost of goods sold (COGS).

• Liabilities and expenses have several key differences, but both are essential for managing your company’s finances and planning for the future.

Liabilities are debts or financial obligations that a business owes to outside parties, such as vendors or suppliers. These can include accounts payable, outstanding invoices and short- and long-term loans—any type of transaction that will require future payment or services.

Liabilities are listed on your company’s balance sheet and directly impact your business’s assets and equity. There are several types of liabilities, and understanding each one is essential for assessing your business’s financial health and managing future cash flow.

Common types of liabilities include current liabilities, noncurrent liabilities (also known as long-term liabilities) and contingent liabilities.

Current liabilities are often paid with current assets and are due within a year. These can include financial obligations such as:

• Accounts payable or money owed to suppliers
• Payroll expenses
• Short-term loans
• Taxes owed
• Monthly utilities

Other examples of current liabilities include wages payable, dividends payable, interest payable and unearned revenues—money received in advance for services yet to be completed.

Noncurrent liabilities are obligations due after one year or longer. It’s common for businesses to incur long-term debt, also known as bonds payable, to finance their ongoing operations. Examples of long-term liabilities include:

• Long-term loans
• Leases
• Pension obligations
• Deferred tax liabilities
• Contingent liabilities are possible obligations that could become actual liabilities. They aren’t guaranteed and depend on a specific event happening, such as a lawsuit or a customer invoking a warranty.

Expenses are costs a business incurs to operate and generate revenue. Understanding your expenses is essential because they reduce your net income. Tracking expenses can help with budgeting and tax deductions and provide an overview of your finances. Properly managing expenses can also lead to higher profitability.

Businesses report expenses on their income statements. Some expenses may be tax-deductible, as long as they are considered “ordinary and necessary” for the business, according to the IRS.

Expenses are typically recurring payments that are necessary to run a business. There are two main types of expenses.

• Operating expenses: Operating expenses are the regular costs involved in running a business. These include rent or lease payments, employee salaries, utilities, marketing and advertising costs, administrative fees, office supplies, COGS and more. 

• Nonoperating expenses: Nonoperating expenses are costs not directly tied to the business’s daily operations, such as restructuring costs or interest charges on loans and other debt.

Think of expenses as the costs of running the business now and liabilities as financial commitments that need to be paid in the future. While both involve money the business has to pay, liabilities and expenses serve different purposes in accounting and financial analysis.

Here’s an example of how liabilities and expenses might impact a small business, such as a boutique clothing retailer. If the business owner purchases inventory and pays for it immediately, that’s an expense. The money is spent to operate the business now, and the cost will appear on the income statement. 

However, if the same business owner chooses to buy inventory on credit, with the bill due in 60 days, this is considered a liability because no money has exchanged hands yet—it’s owed to the supplier. This liability will show up on the balance sheet as accounts payable. When the invoice is paid, the liability is removed and the cost is recorded as an expense. 

Here are some key differences between liabilities and expenses that all business owners should understand.

A key difference between liabilities and expenses is their purpose and what they represent. Liabilities are amounts the company owes to others, such as lenders, creditors and suppliers. On the other hand, expenses are costs incurred to generate revenue and keep operations running. In this sense, you can consider timing to be an important distinction between liabilities and expenses. 

Liabilities are recognized when an obligation is created that will require payment in the future. For example, if you receive a bill from the electric company on June 1, that’s considered a liability because it’s recorded in accounts payable. Once the bill is paid, it becomes an expense on the income statement and the liability is removed. 

Expenses are recognized as soon as the resource or service is used, not necessarily when the payment is made. For example, rent is considered an expense during the month you occupy the space, even if the bill hasn’t been paid yet.

Liabilities are listed on the balance sheet and represent what the business owes. They help business owners understand the company’s ability to meet financial obligations and how much it relies on outside financing.

Expenses are reported on a company’s income statement and represent the costs of running the business during a specific accounting period. Some examples include marketing, rent and salaries. These costs are subtracted from the business’s revenue to calculate net income, which is a key indicator of the company’s performance. By accurately tracking expenses, business owners have a clearer picture of their profitability and efficiency. 

It’s essential to properly report both liabilities and expenses. Inaccurately or incorrectly reporting them can impact your company’s financial well-being and decision-making.

Liabilities are classified as current or noncurrent. Current liabilities are due within a year and include costs such as payroll, accounts payable and other short-term obligations. Noncurrent liabilities are long-term debts or obligations that are due beyond a 12-month period.

Expenses are classified as operating and nonoperating. Operating expenses are the costs incurred from daily business activities, while nonoperating expenses include things like interest charges and other costs not related to core operations. 

Properly classifying liabilities and expenses is key to assessing your company’s short- and long-term financial health. They’re also essential to understanding its performance and ensuring accurate financial analysis.

Liabilities and expenses both influence your business’s financial health but in different ways. Since liabilities aren’t part of the income statement, they don’t directly impact profit—but they do affect equity and assets. On the other hand, expenses directly affect profits—especially when operating costs increase. 

Changes in liabilities can also affect cash flow. For example, if the company delays paying a vendor, accounts payable increases, which could temporarily improve cash flow. However, when the invoice is paid, it becomes a cash outflow, reducing the company’s available funds.

It’s essential to understand these differences. Underreporting expenses will overstate profits. At the same time, ignoring liabilities until they’re due can lead to poor cash flow management and planning—both of which lead to inaccurate budgeting and forecasting.

Liabilities and expenses both play a role in accounting for and managing your business’s finances, but they serve different purposes. They appear in different financial statements, have varying durations and impact your company’s bottom line in different ways. A liability is money owed in the future, while an expense is a cost incurred to help the business run smoothly and generate revenue.

If you’re considering a business credit card to help you manage your finances and track expenses, you can get pre-approved with Capital One to find a card that meets your company’s needs and supports business growth.