Liability refers to the legal responsibility a company or individual has for debts, obligations, or potential losses, which may require the payment of compensation or damages to another party.
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A liability, by definition, is something you are responsible for. Businesses have two broad types of liabilities. Accounting liabilities and legal liabilities.
In business accounting, the term liability refers to money a self-employed person or company owes another party and is required to repay. In most cases, liabilities arise from loans or other forms of borrowing.
There are three categories of accounting liabilities: current liabilities, long-term liabilities, and contingent liabilities. Current liabilities are also called short-term liabilities. They are debts that are payable within a year. Long-term liabilities are those that extend beyond one year such as mortgages or vehicle loans. Contingent liabilities are debts a business might incur depending on the outcome of some future event.
Among the short-term liabilities that commonly appear on small business balance sheets are:
Typical small business long-term liabilities include:
For small businesses, the most common type of contingent liability would be the damages they may have to pay if they are being sued.
Borrowing and owing money are a normal part of running a business. Pretty much every business has short-term liabilities for things such as credit card purchases, utilities and internet services, advertising expenses, bills from contractors, and other operational necessities. These liabilities, along with debt incurred for major purchases are advantageous to a business when the borrowed money helps the business grow and succeed.
Among the disadvantages of business debt are the cost of interest on loans, the impact on cash flow, the need to continue making payments during seasonal or other downturns in business, and the effect of debt on a business’s credit rating and valuation.
Legal liability refers to a business being held financial responsibility for injuries or losses caused by the actions or inactions of the business. Injury caused by defective products, errors and omissions, trips and falls, loss of data are among possible legal liabilities a business for which a business might be sued. Businesses that are hit with liability suits often incur significant legal fees to defend themselves, even if they win the case.
There are many potential legal liabilities for businesses. Here are some common small business legal liability situations.
Product Liability. A product you manufacture malfunctions or is hazardous and causes injury to a purchaser or to something they own. While product liability cases most people hear about involve major corporations, small businesses can be sued for product liability, too. For instance, a person who manufactures hand-made soaps might be sued if their soaps cause an allergic reaction, or the colorants in the soap permanently discolor a sink or countertop.
Property Damage. Something your company does causes damage to someone’s property. For example, if your business power washes a home and damages the siding, you could be sued. Similarly, if your HAVC company damages a water pipe which leaks, causing extensive flooding damage in the building, you can be sued.
Slip, Trip and Fall Injuries. This is when the actions or carelessness of the business or someone working for the business causes someone to trip and fall and be injured. For example, if someone trips over your toolbox or an electrical cord and falls and breaks their hip, you could be sued.
Liability for Employee or Contractor Injuries. If an employee or an independent contractor you hire is injured on the job, your company could be sued. If you are a roofer, for instance and an employee or day laborer falls off a roof while they are working you could be sued.
Professional Liability. Doctors aren’t the only types of businesses that are subject to professional liability. Consultants, technology companies, and any company that might make errors or unintentionally give bad advice that causes an individual or company harm can be sued.
Employee Issues. Sexual harassment, unfair labor practices and defamation are among some of the potential liabilities an employer has.
Business Owner Liability. In some circumstances business owners can be held personally liable and have to use their personal savings or assets to pay off loans, debts, legal judgments, and legal fees their businesses have incurred.
For instance, an individual who is a sole proprietor and hasn’t formed an LLC (limited liability company) or corporation, for instance, is totally liable for the debts of the business. Under the law there is no difference between a sole proprietor and the business. For more information please see: What is a Sole Proprietorship?
Individuals who do form LLCs or S corporations can become personally liable for a company’s debts by signing personal guarantees for those debts. Among other circumstances in which an LLC or S corporation owner might be personally liable is if they comingle personal and business funds or otherwise fail to keep the business separate from their personal affairs, are personally negligent, or fail to pay taxes.
Forming your business as an LLC or an S corporation makes the business a separate entity from you, the owner. Thus, it can help shield your personal assets if the business can’t pay its bills or is sued.
In addition, business liability insurance can protect your business and yourself from losses. Every business should have at minimum a general liability policy, often referred to a Business Owners Policy for small businesses. This covers general liability such as trip, slip and fall, as well as fire damages and similar losses. Depending on the nature of the business, other types of insurance such as professional liability insurance (also called errors and omissions), commercial auto insurance, workers’ compensation insurance, or specialty insurance (such as insurance for roofers, say) may be advisable.
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Disclaimer: The content on this page is for information purposes only and does not constitute legal, tax, or accounting advice. If you have specific questions about any of these topics, seek the counsel of a licensed professional.
Written by Team ZenBusiness
ZenBusiness has helped people start, run, and grow over 700,000 dream companies. The editorial team at ZenBusiness has over 20 years of collective small business publishing experience and is composed of business formation experts who are dedicated to empowering and educating entrepreneurs about owning a company.
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