The article discusses current liabilities, the formula to calculate them, their importance, and management.
Businesses sometimes use an account called other current liabilities as a general item on their balance sheets to include all other liabilities due within one year that are not classified elsewhere. Current liability accounts can vary by industry or in accordance with various government regulations. In this article, we will cover the concept of current liabilities and their management.
- What are Current Liabilities?
- Structuring of Current Liabilities
- Importance Of Current Liabilities
- Examples of Current Liabilities
- Valuation of Current Liability
- Management of Current Liability
- Key points
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What are Current Liabilities?
Current liabilities, also called short-term liabilities, are part of a company’s liabilities that contain its debts and obligations for less than one year. In other words, short-term obligations and debts.
They are generally a source of financing with a low financial cost. For example, it is possible to get suppliers to sell you merchandise on credit for 30 or even 90 days without charging financing.
For this reason, the company must accurately identify its current liabilities to attend to them correctly and efficiently within its planning and budget.
If the company has high short-term obligations and does not have sufficient cash flow or current assets to cover such liability, no creditor or supplier will want to finance it. The company’s risk of failing to comply with new obligations is high.
So, current liabilities are essential data for the company’s directives and third parties interested in financing or investing.
Current Liabilities formula = Notes payable + Accounts payable + Accrued expenses + Unearned revenue + Current portion of long-term debt + other short-term debt.
Structuring of Current Liabilities
Current liabilities are made up of various accounts, such as:
- Short term debts
- Short-term provisions
- Debts with group companies and short-term associates
- Short-term trade creditors
- Other short-term accounts payable
- Liabilities linked to non-current assets held for sale.
What is the Importance of Current Liability?
Its importance is that all companies need financing to function and carry out their different economic activities, achieved through liabilities.
- It allows the development of the productive and commercial activity of the company by having financing for its operations.
- Together with current assets, it allows you to achieve a good liquidity ratio and always have cash available for different purposes.
- Allows you to sort company accounts.
Related – What is a Fiscal Deficit?
Examples of Current Liabilities
Some common examples include ordinary accounts payable and business tax debt (or its estimate). It also considers income tax and insurance premiums the business pays on behalf of its employees. If a business declares a dividend but has not paid it, it will also be considered a current liability.
In specific business sectors, deferred revenue is also a typical current liability. Deferred revenue occurs when a customer pays for a product or service in advance to receive it later. These payments will also appear as income on the company’s profit and loss statement.
If the company obtains financing, this will likely be included among current liabilities. The total cost (principal and interest) will be shown as a current liability if it is a short-term debt. In the case of long-term debt, the principal may be a long-term liability, but the recurring cost related to interest payments could be included here.
It can also include operating expenses (OPEX). In contrast, capital investment (CAPEX) does not fall into that category, as it typically involves significant investments and possibly long-term debt. Now, it is possible to include capital investment.
Valuation of Current Liability
Some current liabilities have a fixed cost, but many have variable costs. For example, debts may have variable interest rates. Employers may have to pay higher income tax if employees work overtime. In addition, companies that receive deferred revenue may incur additional costs in meeting their obligations to customers.
Companies must predict these costs as accurately as possible. First, they must include them in the budget. In addition, these costs are often a key element in both short- and long-term financial planning.
On the other hand, it is prudent to acknowledge that some of these costs are extremely difficult to predict and, therefore, difficult to budget for. If this situation can potentially cause problems for a business, it may be worthwhile to purchase the appropriate insurance.
Management of Current Liability
A business’s cash flow often depends mainly on its ability to manage current liabilities. Put more simply, businesses must do their best to ensure that their current assets are converted to money before current liabilities mature.
For example, many businesses prefer or need customers to pay their bills to pay their suppliers (and even their employees). This should be achieved through robust billing processes and effective credit monitoring.
However, having backup measures can be helpful. If, for example, the customer is late in paying their debt, it may be possible to pay the supplier with a commercial credit card.
- Current liabilities are a company’s short-term financial obligations due within one year or a normal operating cycle.
- Current liabilities are generally settled using current assets, which are depleted within a year.
- Examples include accounts payable, short-term debt, dividends and notes payable, and income taxes payable.
- Current liability analysis is important to investors and lenders. This can give an image of the financial situation of a company and the management of its current liabilities.
It is essential to maintain good liability management and classify them correctly. During audits, the auditors may want to study the balances. If the company has high current liabilities and needs more cash flow or enough current assets to cover those liabilities, surely no creditor or supplier will want to finance you since the risk of non-payment of the new obligations is high.
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How are current liabilities different from long-term liabilities?
Current liabilities are obligations that are due within one year, while long-term liabilities are debts or obligations with a repayment period longer than one year.
Can current liabilities change over time?
Yes, current liabilities can change over time based on factors such as business operations, repayment schedules, borrowing activities, and changes in the economic environment.
What are accrued expenses in relation to current liabilities?
Accrued expenses are costs that a company has incurred but has not yet paid. They are recorded as current liabilities until they are settled.
Are current liabilities always settled with cash?
While cash is commonly used to settle current liabilities, some may be settled with other assets or through the transfer of goods or services.
Can current liabilities include non-monetary obligations?
Yes, current liabilities can include non-monetary obligations such as warranty liabilities, customer deposits, or deferred revenue, which represent obligations to provide goods or services in the future.
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