What Are Current Liabilities?
Current liabilities are the obligations of the company which are expected to get paid within one year and include liabilities such as accounts payable, short term loans, Interest payable, Bank overdraft and the other such short term liabilities of the company.
The meaning of current liabilities does not include amounts that are yet to be incurred as per the accrual accountingAccrual AccountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. . For example, the salary to be paid to employees for services in the next fiscal yearFiscal YearFiscal Year (FY) is referred to as a period lasting for twelve months and is used for budgeting, account keeping and all the other financial reporting for industries. Some of the most commonly used Fiscal Years by businesses all over the world are: 1st January to 31st December, 1st April to 31st March, 1st July to 30th June and 1st October to 30th September is not yet due since the services have not yet been incurred.
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Current Liabilities Explained
Current Liabilities on the balance sheet refer to the debts or obligations that a company owes and is required to settle within one fiscal year or its normal operating cycle, whichever is longer. These liabilities are recorded on the Balance Sheet in the order of the shortest term to the longest term.
Most Balance sheets separate current liabilities from long-term liabilities. It gives an idea of the short-term dues and is essential information for lenders, financial analysts, owners, and executives of the firm to analyze liquidity, working capital managementWorking Capital ManagementWorking Capital Management refers to the management of the capital that the company requires for financing its daily business operations. It is important for the company in order to maximize its operational efficiency, manage its short term liabilities and assets properly, avoiding the underutilization of the resources and avoiding the overtrading, etc., and compare across firms in the industry. Being part of the working capital is also significant for calculating free cash flow of a firm.
Although it is more prudent to maintain the current ratio and a quick ratio of at least 1, the current ratio greater than one provides an additional cushion to deal with unforeseen contingencies. Traditional manufacturing facilities maintain current assetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc. at levels double that of current liabilities on the balance sheet. However, the increased usage of just-in-time manufacturing techniques in modern manufacturing companies like the automobile sector has reduced the current requirement.
Current Liabilities in Video
The list of current liabilities below shows the components that play a vital role:
#1 – Accounts Payable
Accounts PayableAccounts PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period. is usually the major component representing payment due to suppliers within one year for raw materials bought, as evidenced by supply invoices.
Here is the example
We note from above that Accounts Payable of Colgate is $1,124 million in 2016 and $1,110 million in 2015.
#2 – Notes Payable (Short-term)
Notes PayableNotes PayableNotes Payable is a promissory note that records the borrower's written promise to the lender for paying up a certain amount, with interest, by a specified date. are short-term financial obligations evidenced by negotiable instrumentsNegotiable InstrumentsA negotiable instrument refers to the transferrable and signed written document whereby the payer guarantees or promises to pay a certain sum on a specific future date or as on-demand to the payee or bearer. It includes bills of exchange, delivery order, promissory note, customer receipt, etc. like bank borrowings or obligations for equipment purchases. Maybe interest bearing or non-interest bearing.
Notes and loans payable for Colgate are $13 million and $4 million in 2016 and 2015, respectively.
#3 – Bank Account Overdrafts
Short term advances made by the banks to offset accountOffset AccountOffset account is an account which is directly or indirectly related to another account. It reduces the balance of the related account to give us a net balance which is used for calculation, valuation, interpretation, and application in financial statements as the requirement may arise in the course of business and statutory requirements. overdrafts due to excess funding above the available limit. Also, have a look at the revolving credit facilityRevolving Credit FacilityA revolving credit facility refers to a pre-approved loan facility provided by banks to their corporate clients. It states that the companies are free to borrow funds from these financial institutions to fulfill their cash flow needs by paying off the underlying commitment fees.
#4 – Current portion of long-term debt
Current portion of long-term debtCurrent Portion Of Long-term DebtCurrent Portion of Long-Term Debt (CPLTD) is payable within the next year from the date of the balance sheet, and are separated from the long-term debt as they are to be paid within next year using the company’s cash flows or by utilizing its current assets. is a part of the long-term debt due within the next year
#5 – Current Lease payable
Lease obligations due to the lessorLessorA lessor is an individual or entity that leases out an asset such as land, house or machinery to another person or organization for a certain period. in the short-term
Facebook’s current portion of the capital lease was $312 million and $279 in 2012 and 2011, respectively.
#6 – Accrued Income Taxes or Current tax payable
Income Tax owed to the government but not yet paid
We note from above that Colgate’s accrued income tax was $441 million and $277 million, respectively.
#7 – Accrued Expenses (Liabilities)
Expenses not yet payable to the third party but already incurred like interest and salary payableSalary PayableSalary payable refers to the liability of the company towards its employees against the amount of salary of a period that became due but has not been paid yet to them by the company and it is shown in the balance of the company under the head liability.. These accumulate with time. However, they will get paid when they become due. For example, salaries that the employees have earned but not been paid are reported as accrued salaries.
Facebook’s accrued liabilitiesAccrued LiabilitiesAccrued liabilities refer to the obligations against expenses which the company incurs over one accounting period; however, it has not made any monetary payment for such expenses in the same accounting period. These expenses appear as liabilities in the corporate balance sheet. are at $441 million and $296 million, respectively.
#8 – Dividend Payable-
Dividends payables are Dividend declaredDividend DeclaredDividend declared is that portion of profits earned that the company’s board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the company’s securities., but yet to be paid to shareholders.
#9 – Unearned Revenue-
Unearned revenuesUnearned RevenuesUnearned revenue is the advance payment received by the firm for goods or services that have yet to be delivered. In other words, it comprises the amount received for the goods delivery that will take place at a future date. are advance payments made by customers for future work to be completed in the short term like an advance magazine subscription.
The below example details of unearned subscription revenues for a Media (magazine company)
How To Calculate?
Current liabilities on the balance sheet impose restrictions on the cashRestrictions On The CashRestricted cash is the portion of cash that has been set aside for a specific purpose. It is usually held in a special account (for example, an escrow account) so it remains separate from the rest of a business’ cash and equivalents. flow of a company and have to be managed prudently to ensure that the company has enough current assets to maintain short-term liquidity. In most cases, companies are required to maintain liabilities for recording payments which are not yet due. Again, companies may want to have liabilities because it lowers their long-term interest obligation.
Some of the essential ways you can analyze them are 1) Working Capital and 2) Current Ratios (& Quick Ratio)
#1 – Working Capital
Working capital is the capital that makes fixed assetsFixed AssetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples. work in an organization. Working capital can be calculated as follows:
Working Capital formulaWorking Capital FormulaWorking capital is the amount available to a company for day-to-day expenses. It's a measure of a company's liquidity, efficiency, and financial health, and it's calculated using a simple formula: "current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)" = Current Assets – Current Liabilities
- A company’s liquidity position can be gauged by analyzing its working capital. Excessive working capital means that the level of current assets is much higher on the balance sheetThe Balance SheetA balance sheet is one of the financial statements of a company that presents the shareholders' equity, liabilities, and assets of the company at a specific point in time. It is based on the accounting equation that states that the sum of the total liabilities and the owner's capital equals the total assets of the company.. This excess capital blocked up in the assets has an opportunity cost for the firm since it can be invested in other areas for generating higher profits instead of staying idle within working capital.
- On the other extreme, inadequate working capital may pose short-term liquidity issues if the company maintains current assets which are not sufficient enough to meet the liabilities. Consistent liquidity issues may pose problems in the firm’s smooth functioning and affect the company’s credibility in the market.
#2 – Current Ratio & Quick Ratio
Current Liabilities on the balance sheets are also used to calculate liquidity ratios like the current ratio and quick ratio. These ratios are calculated as follows:
Current Ratio= Current Assets (CA) /Current Liabilities (CL) and
Quick Ratio= (CA- Inventories)/CL
- While working capital is an absolute measure, the current ratio or working capital ratioWorking Capital RatioThe working capital ratio is the ratio that helps in assessing the financial performance and the health of the company where the ratio of less than 1 indicates the probability of financial or liquidity problems in the future to the company, and it is calculated by dividing the total current assets of the company with its total current liabilities. can be used to compare companies against peers. The ratio varies across industries, and 1.5 is usually an acceptable standard. A ratio above 2 or below 1 indicates inadequate working capital management.
- The Current RatioCurrent RatioThe current ratio is a liquidity ratio that measures how efficiently a company can repay it' short-term loans within a year. Current ratio = current assets/current liabilities is used in the financial analysis along with a quick ratio, which measures a company’s ability to meet its liabilities using its more liquid assets. A company may boast of a high current ratio. However, most of its current assets can be in the form of inventories, which are difficult to convert into cash and hence, are less liquid. In case of immediate funds requirement for meeting liabilities, these less liquid assets would be no help to the company.
- A quick ratioA Quick RatioThe quick ratio, also known as the acid test ratio, measures the ability of the company to repay the short-term debts with the help of the most liquid assets. It is calculated by adding total cash and equivalents, accounts receivable, and the marketable investments of the company, then dividing it by its total current liabilities. of less than 1 would signify that the company would be unable to pay back its short term liabilities. Thus a quick ratio is also referred to as the acid test ratioAcid Test RatioAcid test ratio is a measure of short term liquidity of the firm and is calculated by dividing the summation of the most liquid assets like cash, cash equivalents, marketable securities or short-term investments, and current accounts receivables by the total current liabilities. The ratio is also known as a Quick Ratio., which speaks of a company’s financial strength.
Let us consider a current liabilities example here for a retail industry:
In the retail industry, the current ratio is usually less than 1, meaning that current liabilities on the balance sheet are more than current assetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc..
As we note from above, Costco’s Current Ratio is 0.99, Walmart’s Current ratio is 0.76, and that of Tesco is 0.714.
- Retailers like Walmart, Costco, and Tesco maintain minimal working capital since they can negotiate longer credit periods with suppliers but can afford to offer little credit to customers.
- Thus they have much higher accounts payable compared to accounts receivableAccounts Payable Compared To Accounts ReceivableWhile Accounts Receivable is the capital amount that the clients/customers owe to the business, Accounts Payable is the capital amount that the business owes to its suppliers. .
- Such retailers also maintain a minimal inventory through efficient supply chain management.
Current Liabilities Vs Non-Current Liabilities
Both current liabilities and non-current liabilities, also known as long-term liabilities, form part of the balance sheet of a company. The difference between the two is as follows:
- Current liabilities are short-term debts, while the latter includes long-term loans and leases.
- The former reduces the working capital funds that the businesses have. On the contrary, non-current liabilities help fund capital expenses through bank loans, etc.
- Examples of the former include utility payments, credits for goods purchased, and other short-term loans. On the other hand, long-term liabilities include bank loans, bonds, debentures, etc.
This article is a guide to what are Current Liabilities. Here we explain it with an example and check how to calculate it, vs non-current liabilities & types. You may also have a look at the following recommended articles on accounting basics –