What are Current Liabilities: Understanding in the balance sheet

by Eduyush Team

Assuming you have a basic understanding of accounting, current liabilities are those obligations of a company that are due within one year. In other words, they are debts that must be paid shortly. A typical example would be money owed to suppliers for Inventory purchased on credit. 

Trade payables like these typically have payment terms of 30 days or less. Other current liabilities might include things like short-term loans and accrued expenses. Let's look at each type of current liability in a little more detail.

What do current liabilities mean?

Current liabilities are short-term debts that must be repaid within one year by a company. They differ from long-term liabilities, debts that must be repaid in more than one year.

 Current liabilities usually include money owed to vendors, taxes, and accounts payable. This is different from a company's net income and cash flow, which represent the company's profitability.

What are examples of current liabilities?

Current Liabilities (debts that will come due within the next year) can be either of the following. They typically include taxes, payroll, accounts payable, and the current portion of long-term debt.

  • Taxes: Tax obligations are generally the most significant current liability for any business. 
  • Payroll: When you hire employees, you incur several obligations, including payroll tax obligations, worker's compensation insurance, and other benefits. 
  • Accounts payable: These are bills for goods and services your company has already received but for which you have not yet paid. 
  • Current portion of long-term debt: Your company may have long-term debt, such as a mortgage on the property, and short-term debt, such as money you borrowed to meet operating expenses until the long-term debt is paid. 
  • Deferred revenue is money you receive from customers but have not yet earned.
  • Accrued expenses: Sometimes, a business incurs costs that it cannot pay immediately. For example, a business owner may sign a contract to pay an employee a $10,000 bonus at the end of the year. Because the business can't pay the bonus immediately, it records the obligation as an accrued expense in the company's books. This is because the business will eventually have to pay the bonus out.

An example of a company with current liability is Walmart. The company notes its current liabilities of $51.8 billion in Walmart's annual report. This number represents the money the company currently owes to its creditors. Most of this amount comprises short-term debt, trade payables, and long-term debt due within one year.

Is contingent liability a current liability?

No, a contingent liability is not a current liability. A contingent liability is a potential liability that may or may not arise in the future. For example, if your company enters into a contract with another company and there is a chance that the other company will not hold up their end of the bargain, then your company would have a contingent liability.

On the other hand, a current liability is an obligation that your company currently owes to someone else. Examples of current liabilities include accounts payable, wages payable, and unearned revenue.

What does an increase in current liabilities mean?

An increase in current liabilities means the company has more debt that it needs to pay back shortly. This can signify financial instability and lead to difficulties in paying creditors.

It's important to note that increasing current liabilities doesn't always mean a company is in trouble. It could result from a one-time event, such as a major purchase or investment. However, if it's part of a trend, then it may be cause for concern.

What is the current liabilities formula?

The current liabilities formula comprises three components: Current liabilities = Accounts payable + Notes payable + Accrued expenses. 

Each of these individual terms can be explained as follows: 

-Accounts payable: Amounts owed to suppliers for goods and services received but not yet paid for. 

-Notes payable: Amounts owed to lenders in the form of a signed promissory note. 

-Accrued expenses: Unpaid bills or expenses that have arisen since the last accounting period ended.

Why do investors care for current liabilities?

Current liabilities are essential because they show how much money a company has to pay its bills. The larger the current liabilities, the more significant the company's cash needs. 

If a company's cash flow is insufficient to pay current liabilities, creditors may demand payment before equity holders. Investors care about current liabilities because it shows how much of a strain the company has on meeting its payment obligations. If the current liabilities exceed the cash flow of the company, then the company may need to take on debt or equity.

Accounting for Current Liabilities

Current liabilities are recorded in accounts payable and accrued expenses. They are also offset by current assets, such as cash, Inventory, and marketable securities. 

The difference between these two figures is net current assets (NCA). One of the main reasons for having a balance sheet is to show the relationship between a company's assets and liabilities. 

The balance sheet will typically include the total amount of the company's assets on one side and the total amount of the liabilities, and the owner's equity on the other. The totals on each side will be equal, referred to as being in balance.

Summing up

It is crucial for businesses, big or small, to understand and monitor their current liabilities. This gives them an idea of how much cash they will need to have to meet their financial obligations in the short term. If you want to learn more about accounting and keeping track of your company's finances, we offer both IFRS and USGAAP courses that can help you better understand these concepts.


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FAQs

There are several key similarities between current and fixed assets. Both represent investments in the long-term success of a business, and both offer financial benefits through depreciation and tax deductions. In addition, careful management of either type of asset can help to improve the bottom line.

However, there are also some important distinctions between current and fixed assets. For example, current assets are typically more liquid than fixed assets, meaning they can be converted into cash more quickly. Current assets are also generally less expensive to acquire and maintain than fixed assets. Finally, while all businesses need both types of asset, the focus on each varies depending on the size and nature of the company.

The list of current assets includes cash, marketable securities, accounts receivable, inventories, and prepaid expenses. Each company will have a different list of assets depending on the type of business it is in and the products or services it offers. For example, a technology company would have a higher concentration of marketable securities and accounts receivable on its balance sheet than a grocery store.

Yes, a company's current assets can be more than its total liabilities. For example, a company may have $10 in cash and $5 in Accounts Receivable (AR), which would give it a current ratio of 2 ($10/$5). This means that for every dollar the company owes in short-term debt or other liabilities, it has two dollars in readily available assets that can be used to pay off those debts.

While a high current ratio is generally seen as a good sign, it's not foolproof. For example, if a company's Accounts Payable (AP) are also high, it may be indicative of liquidity problems. This is because AP are liabilities that will eventually need to be paid off.

The most common measure of a company's liquidity is current assets minus current liabilities. This is also called the working capital ratio. It measures a company's ability to pay its short-term obligations.

A high working capital ratio usually indicates that a company has a lot of cash and equivalents on hand, which can be used to pay its short-term liabilities. A low working capital ratio usually means that a company doesn't have enough cash and equivalents on hand to pay its short-term liabilities. This could be a sign that the company is in financial trouble.

Supplies are considered current assets. This is because the company expects to use the supplies within one year or less. The cost of the supplies is not recorded as an expense until the goods are used or consumed.

When a company purchases supplies, it records the purchase as an asset on the balance sheet. The cost of the supplies will be listed as part of the current assets section of the balance sheet until they are used or consumed. Once they are used or consumed, then the cost of the supplies will be moved over to the expenses section of the income statement and will impact net income for that period.

Provisions are current liabilities if they are expected to be settled within 12 months, and non-current liabilities if they are not expected to be settled within 12 months.