Understanding your company’s current liabilities is an essential part of running a successful business. The current liabilities section of a balance sheet shows the debts that a company owes. The obligations are usually to be paid within one year.
An issue may arise if you are not aware of how much money is owed on any particular date. This could negatively affect cash flow and the ability to purchase inventory or pay employees.
This blog post will look at the definition of ‘current liabilities,’ how current liabilities work, and the examples of current liabilities.
What are Current Liabilities?
Current liabilities is a term that describes all of the obligations and debt that a company has to pay off within 12 months. Current liabilities examples are accounts payable, taxes payable, salaries, loans, and other existing debts.
Current liabilities are not to be confused with long-term debt or equity financing. To calculate your company’s current liability balance, add all the liabilities up. The result is how much you owe but don’t currently have to pay off right now.
It also includes short-term debt like credit card balances or loans with your bank. It may seem like a lot, but it becomes much easier to manage all aspects of your business with this information in hand.
The key takeaways current liabilities are:
- Short-term obligations that must be paid in a year or less.
- Accounts payable is the most significant liability for a company.
- A company should have more current assets than current liabilities.
- Some current liabilities include accrued payroll, accrued expenses, customer deposits, sales taxes payable, interest payable, notes payable, and other current liabilities.
- They are part of the balance sheet
Accounting for Current Liabilities
As with all accounting, current liabilities are part of double entry bookkeeping. So for each entry, there will be an equal and opposite entry.
For example, you must record it in the current liability account when you take out a loan. When you pay down on that same debt, credit it and debit cash or bank. That will also help you keep track of the amount of money owed.
When a company has an expense that it cannot afford to pay immediately, it must create an account for that liability. For example, if you do not have enough money in your bank to pay your employees on December 31, you must create an account to track how much they will get paid.
Once the liability account is created, you must record all of the expenses related to that liability. Then on December 31, you have to debit the expense and credit the liability account for how much money is owed.
Accounting Software for Current Liabilities
Set up separate account codes for each liability account, most will have the main ones already set up on the chart of accounts.
Why Current Liabilities Are Important to Monitor
It is crucial to monitor your current liabilities because they can be a sign of pending financial trouble. If your current liabilities are higher than your available cash, the company could be headed for a financial crisis.
For example, if you cannot pay debts in time that it is due, this could be an indicator of financial trouble. If you take out a loan and can’t make payments, this could be a sign that the company is in the process of closing.
These are just two current liabilities examples that you should monitor regularly. If your business cannot pay its current liabilities in full, you will not be able to run your business correctly. So monitoring your current liabilities is an essential part of running your business.
How do Current Liabilities Work?
When you think of a balance sheet, what comes to mind? Current liabilities. If you are ever in business, whether big or small, you will have to deal with current liabilities. So how do these work? Assets and Liabilities are the two categories that make up your company’s balance sheet.
Assets add value to companies. They are things that help them be worth more money. On the other hand, liabilities make a company worthless because they cost money. They work together as each other’s opposites: one increases the former; another decreases it.
When a company operates, it must know how much cash and current assets they have on hand. If there were no liabilities to pay current ones, the company would not have enough money for operations or future debts. This is why businesses need working capital which can come from many places. Such as bank loans, investors, commercial borrowings, customer deposits, and accounts receivable.
The current ratio is a financial ratio that measures the liquidity of a company’s current assets to its current liabilities. A company with a high level of cash flow and low debt will have a higher ratio than one with low levels. This may indicate an inability to meet short-term obligations.
Below is the formula showing how to calculate the current ratio:
To determine whether or not a company is financially healthy, you can compare its short-term liabilities to its current assets. If there is not enough cash available right now, maybe some more work needs doing before year-end. So as not to cause short-term problems, which can create inconsistencies in business and put pressure on the line.
Examples of Current Liabilities
Accounts Payable: This is the money that a company owes for goods and services received. Accounts payables are the most significant current liability that includes all debts owed to suppliers within one year. The supplier may be a vendor, a distributor, or an independent company selling to the grocery store.
Accrued Payroll: This is a liability for an employer because it’s the money they owe their employees. It includes Salaries, Wages, holiday pay, sick pay, bonuses, and other types of payment.
Accrued expenses: A liability for a business if they owe money to their creditors or third parties, but it has not yet been paid. It often consists of short-term liabilities such as utility bills or other costs due shortly.
Customer Deposits: This is the money customers have paid in advance for goods or services not yet provided.
VAT: Sales or income taxes payable is the money that a company has already collected for sales tax, but it hasn’t been paid yet. This is an example of a current liability because it’s money owed to the government or other financial institutions.
Interest payable: This is money that a company owes due to taking out a loan and yet not paying to the lender.
Short-Term Debt: This is money that the company owes to financial institutions. It’s described as “short term” because companies usually have to pay it back within one year or less.
Current maturities of Long-Term Debt: This is money that the company owes to financial institutions. It’s described as “long term” because it will be paid back over more than one year.
Dividends payable: This is the money that a company owes to its shareholders. It’s a current liability because it usually has to be paid within a year. However, it doesn’t have to be paid immediately if the company cannot afford to pay it.
Payroll taxes payable: This is money that employers take out of your paycheque for taxes. It can be income tax, national insurance or other taxes related to your payment.
Notes payable: This is money that the company owes to others. Notes payable referred to short-term or long-term liabilities, and they have to pay it back within one year or more.
Below is our balance sheet template that shows where the current liabilities are listed.
Why do Investors Care about Current Liabilities?
Investors need to understand current liabilities because they can significantly impact the company’s financial health. Current liabilities are obligations that will be paid in one year or less and include accounts payable, long-term or short-term loans, and taxes.
If investors see that a company has high current liabilities, they might think this is a sign of poor cash flow and not invest in it. However, some companies have high levels of inventory or accounts receivable as well as other current assets. That can make up for their immense level of current liabilities. Investors should be aware of what these numbers mean before making any investment decisions based on them.
It’s essential to be aware of what current liabilities are because, without enough cash, the company cannot operate. This is why it affects companies’ short-term financial stability.
They make up part of the balance sheet, which is one of the main financial statements.