What Are Current Liabilities? (And How To Record Them)
By Indeed Editorial Team
Updated 6 November 2022
Published 4 May 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
Determining what a business operation currently owes in debts and other financial obligations is a good way to evaluate short-term financial standing. To do this, it is essential to acknowledge and factor in financial elements known as current liabilities. Understanding what current liabilities can enable you to evaluate whether a business operation has the monetary means to fulfil various obligations. In this article, we examine what current liabilities are, provide examples and explain how to use and record them.
What Are Current Liabilities?
The answer to the question, "What are current liabilities?" is that they are elements that constitute a company's short-term financial obligations that are due within a year or a normal business cycle. An operating cycle might sometimes last more than a year. It is typically the time it takes for a company to buy inventory and convert it to profits through sales. You can address a current liability within an operational cycle to fulfil pre-existing business conditions. A balance sheet shows your company's current liabilities. This includes accounts payable, repayments towards short-term loans, dividends, notes payable and outstanding income taxes.
A business operation can resolve its current liabilities in a variety of ways, but the most common method is to liquidate current assets into cash or receivables. Another option to settle present liabilities is to replace them with other liabilities, such as a loan. Understanding your company's existing assets and liabilities and their mutual relationship is critical to establishing its financial status. Comparing the numbers for both assets and liabilities can tell you if a company has the financial resources to pay its debts for the year or operating cycle in question.
What Are Current Assets?
Current assets are all of a company's possessions that it projects to sell, consume, use or expend within a year or a cycle of normal business operations. Cash, cash equivalents, accounts receivable, stock inventories, marketable securities, prepaid liabilities and other liquid assets appear on a company's balance sheet. In most cases, institutions can settle their current liabilities using their current assets.
What Is The Relationship Between Liabilities And Investment?
Investors and creditors benefit from performing a thorough examination of a business operation's current liabilities. Banks, for example, may want to know whether a company gets its accounts receivables on schedule before issuing loans. Timely settlement of the company's liabilities is also critical for indicating to investors that their time, effort and money is safe. The current ratio of assets to liabilities is useful for assessing a company's financial solvency and for making intelligent investment decisions.
What Are Some Current Liabilities That Companies List On A Balance Sheet?
Accounts payable, short-term debt such as bank loans and commercial credit to fund operations are the most common current liabilities that companies list on a balance sheet. Notes payable, the principal portion of outstanding debt, current portion of deferred revenue such as prepayments by customers for work in progress, current maturities of long-term debt and interest payable on outstanding debts including long-term obligations and income taxes due in the coming year can also appear on a balance sheet. A company may also create an account called 'other current liabilities' to include all other liabilities due within a year.
Examples Of Current Liabilities
Here are some examples of common current liabilities that companies address:
Accounts payable: Accounts payable refers to funds that a company is to pay for products or services they have already consumed or utilised. Because companies need supplies and products regularly, accounts payable is the most common type of current liability they may face.
Accrued expenses: Accrued expenses refer to payables that have accrued over time. A company is liable to pay back these amounts within a financial year or cycle.
Notes payable or bank loans: This current liability refers to the amount of money a company owes in loans in a financial year or cycle. Companies typically maintain a cash balance that is larger than notes payable, to remain in good financial standing.
Income taxes payable: Income tax is a revenue-dependent amount that a company owes the government. Companies pay income taxes within 12 months and this makes these accounts a current liability.
Wages: This component refers to the wages that a company promises its employees. Because companies typically pay wages within a financial year, wages are a current or short-term liability that business enterprises address periodically.
How Do Companies Use Their Current Liabilities?
Monitoring current liabilities can help you assess a business's ability to repay short-term debts and other obligations consistently. Typically, companies settle current liabilities using their current assets. Current assets include cash and accounts receivables or money due from sales. The current assets to current liabilities ratio is a critical indicator of a company's capacity to meet its debt obligations on time. If a company has more current assets than current liabilities, it may experience good short term financial health. These ratios can help you assess the financial health of a business operation:
1. Current ratio
You can calculate current ratio as a fraction of current assets to current liabilities. You can use the current ratio to determine a company's ability to satisfy short-term financial obligations or debts. The current assets to current liabilities ratio indicates how well a company manages its balance sheet to pay off short-term debts and payables. Using this metric, analysts and creditors can assess how well an organisation is performing financially and how balanced its accounts are.
2. Quick ratio
You can subtract inventory from current assets and then calculate quick ratio as a fraction of the resultant value to current liabilities. The quick ratio examines if a company can meet its short-term financial obligations with its short-term assets. Quick assets are current assets that a company can liquidate immediately. The quick ratio and the current ratio together help determine if a firm can repay its financial loans or commitments to manage its outstanding liabilities.
3. Cash ratio
You can add cash equivalents and cash and then calculate cash ratio as a fraction of the resultant value to current liabilities. This ratio assesses a company's ability to repay short-term debt using cash or cash equivalents alone. Cash asset ratio is another name for this metric. You can use these ratios to see if your organisation has the monetary resources to pay off outstanding loans and obligations.
How To Record Current Liabilities
To understand a company's financial standing, you can accurately account for and record all its current liabilities. Follow these steps to record current liabilities:
1. Determine the type of transaction
This is a crucial step in determining what you owe and for what service or item you owe it. If a hotel has recently received ₹5,00,000 in payment for reservations for the coming month, you may use two transactions to record the interaction. In this particular case, the amount the hotel receives comes with a responsibility to provide a satisfactory service to the consumer.
Since the consumers have not availed the service yet, the money they pay is technically unearned revenue for the hotel. In case of cancellations, the hotel may be liable to repay a portion of the unearned revenue back to the consumer. This constitutes a financial liability on the hotel's balance sheet.
2. Identify the exact nature of the liability
On a balance sheet, you may list both current and long-term liabilities. It is crucial to identify which category a liability comes under, to maintain accurate records. Maintaining accurate records makes it easier for accountants and auditors to read and work with a company's books.
3. Disclose current liabilities
Once you have identified all current liabilities, enter them on the balance sheet. You can list your current liabilities using a spreadsheet. Accounts payable and notes payable are usually at the top of the list because they are the most typical types of current liabilities.
4. Calculate total current liabilities
After you have listed all of your current liabilities, add them all to calculate your total current liability. If a hotel has ₹10,00,000 in notes due, ₹70,00,000 in accounts payable and ₹5,00,000 in unearned revenue from hotel reservations, add these figures together to calculate total current liability. In this situation, the hotel's total current obligation would be ₹85,00,000. If you want to calculate total liability, add long-term liabilities to this figure and record it as total liability on a balance sheet.
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