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Current liabilities, also called short-term liabilities or short-term obligations, are debts a company must pay within one year. They are listed in the liabilities column of a balance sheet, right above long-term liabilities. Items listed under current liabilities are usually paid with cash, although they can instead be replaced by other liabilities, either current or long-term. A company that cannot pay its current liabilities is insolvent and might be forced into bankruptcy if it can't make accommodations with creditors.
How to Calculate Current Liabilities
Current liabilities are defined as:
Current Liabilities = Accounts Payable + Notes Payable + Short-Term Loans + Current Portion of Long-Term Debts + Accrued Expenses + Unearned Revenue + Other Short-Term Debts
The terms used in the definition are:
- Accounts payable: These are accounts representing credit extended by suppliers and vendors for goods and services that have not yet been paid for. For example, if you run a butcher shop and receive three wholesale carcasses on credit, you might have a month before you have to pay for the shipment. The cost of the carcasses is listed under accounts payable until you send payment to the wholesaler.
- Notes payable: These are promissory notes your company has received but not yet repaid. If due within one year, these notes are listed under current liabilities. A promissory note is a signed document in which you promise to pay the note holder a set amount of money no later than a certain date.
- Short-term loans: These are loans, other than promissory notes, that must be repaid within one year. Typical short-term loans include revolving business lines of credit, working capital loans and bridge loans for real estate. Revolving credit lines are often used to smooth out fluctuating cash flows.
- Current portions of long-term debts: Long-term debts are ones in which the full principal amount is due sometime after one year from the date of the balance sheet. Any principal payments on long-term debts scheduled for the next 12 months are listed under current liabilities. This is typically seen in commercial real estate loans, in which part of the principal is repaid monthly.
- Accrued expenses: These are payables that usually stem from periodic expenses that are due but not yet paid. Examples include wages payable, rent payable, utilities payable, interest payable and so forth. When the accrued expense is paid, the payable is removed from the balance sheet.
- Unearned revenue: This is cash you received in advance of delivering a good or service, thereby creating an obligation that you must fulfill within one year. For example, you might sell a $100 gift card to a customer. The $100 will reside in the unearned revenue account until the customer uses the card.
- Other short-term debts: This is a catch-all for other types of debts to be paid within one year. Classification depends on the company's accounting practices, and they might include payroll taxes payable, credit card debts, sales taxes payable and dividends payable.
Consider this excerpt from a company's balance sheet.
|Current Portions of Long-Term Debts||$12,000|
|Other Short-Term Debts||$6,544|
|Total Current Liabilities||$74,604|
The total current liabilities of $74,604 represent obligations that must be paid within 12 months of the balance sheet date. It is a snapshot in time as of that date.
If the balance sheet is published quarterly, you can get an annual average of current liabilities by adding the current liabilities from the four most recent balance sheets and dividing by four. For example, if the quarterly amounts were $83,329; $81,181; $77,590; and $74,604, then the sum would be $316,704, and dividing by four gives average current liabilities of $79,176. The pattern of decreasing values suggests that the company is reducing its short-term indebtedness.
What Financial Metrics Use Current Liabilities?
Current liabilities indicate a company's obligations to pay its short-term bills. It is used in the current ratio, quick ratio and net working capital:
These metrics reveal whether a company has sufficient cash and other current assets necessary to pay its current liabilities. A value below 1.0 (zero for net working capital) indicates a possible problem. Companies might have to increase borrowing, issue new stock or sell off long-term assets to ensure it makes its payments on time. The interpretation for these metrics is highly dependent on the industry in which the company operates. A current ratio of 2.0 is usually considered a comfortable financial cushion in many industries. Lower ratios may not necessarily indicate a problem. For instance, a company with a strong operating cash inflow can probably get away with a lower ratio.
Lenders worry that a company won't be able to make its interest and principal payments, so it naturally wants to see a healthy ability to pay current liabilities. On the other hand, a company with too low a figure for current liabilities might not be operating at peak efficiency because it is failing to use debt to grow the company. Auditors are likely to issue a warning if they feel a company is having recurring problems paying its current liabilities, although this might reduce the company's access to new capital (that is, new debt or equity).