Cash flow is a critical component of business operations. It not only pays for operating expenses and debt liabilities but it represents profit as well. Accrued liabilities, also known as accrued expenses, directly impact cash flow and the financial health of a business enterprise.
Definition of Cash Flow
Cash flow is money streaming into and out of a business. It’s a measure of a company’s liquidity. It’s not the same as its net income, which is the company's profits after all expenses, interest and taxes are considered.
What Are Accrued Liabilities?
Accrued liabilities are financial obligations and irregular or regular expenses that a company or small business owes. But the debts aren’t necessarily due yet and, in most cases, they haven’t yet been formalized by a written invoice or contract.
These liabilities nonetheless represent accounts payable. They must be recorded in a company’s financial statements regardless, even though they’ll be paid at a later date. This situation often arises when goods and/or services are received in one year but won’t be paid for until the next year, according to the University of California, Davis. However, it also applies when goods or services are received in one accounting period but not scheduled for payment until the next accounting period.
The liability must nonetheless be accounted for in an accrual accounting system, according to the Corporate Finance Institute. There are two basic types of accrued liabilities included in the accrual method of accounting. These business expenses are classified as either recurring or routine accrued liabilities, or nonroutine and infrequent liabilities.
They appear on a balance sheet as current liabilities. Accrued liabilities on the balance sheet are reversed when paid. The debit is typically made at the end of the accounting period.
Examples of Accrued Liabilities
Let’s say your business has contracted the services of an attorney to sort through and rectify a legal problem. The attorney performs services and resolves the problem in April. You receive an invoice for $5,000 in June. You remit 25 percent of that, or $1,250, immediately. You’ll pay the remaining $3,750 divided up over three monthly installments.
That $3,750 is an accrued liability, just like credit card debt or other remittances owed to lenders that will be paid in installments. In the case of a loan, the accrued interest expenses must be accounted for as well.
Routine expenses can also be accrued liabilities, such as employee wages to be paid out in future weeks. Accrued wages owed to employees that you anticipate will still be working for you next month would be a routine/recurring liability. The attorney’s charge would be a nonroutine/infrequent liability that’s unlikely to occur again in the foreseeable future.
In all cases, they'll eventually affect the cash flow of the business when they're paid.
Accrued Liabilities and Cash Flow
Accrued liabilities have a direct, albeit temporary, effect on cash flow. They generate temporary positive cash flow for a company to report because they mean that less money is leaving the business, at least in the present accounting period. They’re liabilities that haven’t been paid yet, for which money hasn’t yet flowed out of the business.
The transaction must nonetheless be accounted for because the bottom line is that they are indeed liabilities and thus accounts that are owed. The initial journal entry would include debiting the relevant expense account and crediting the accrued liabilities account.
Tax Effect of Accrued Liabilities
Taxes your business owes but has not yet remitted to federal, state and/or local governments are considered to be accrued liabilities. These include payroll taxes on those earnings you’ve paid to your employees.
Payroll taxes are officially owed to the government but they aren’t payable on the same date you compensate an employee. They’re paid in at regularly set intervals. The IRS indicates that these taxes are technically incurred at the time payment of earnings is made to the employee. They’re therefore considered to be accrued liabilities until the time the taxes are remitted to the federal government.
Taxes on wages paid in the last week of December can technically be accrued until the next calendar year beginning in January if the business uses a calendar year for tax and accounting purposes. This accrual is short-term, perhaps just a matter of weeks, but nonetheless must be recorded.
Beverly Bird has been writing professionally for over 30 years. She is also a paralegal, specializing in areas of personal finance, bankruptcy and estate law. She writes as the tax expert for The Balance.