What are Current Liabilities?
Current Liabilities constitute short-term financial obligations of a business that are anticipated to be liquidated into cash or cash equivalents within a single year or a single business cycle and are recorded in the Liabilities section of the Balance Sheet.
Current Liabilities provide useful insights into the company’s short-term financial standings. They are typically taken into account in combination with the Current Ratio, Quick Ratio, and Working Capital Cycle. Investors, partners, and suppliers gain useful insights to determine the business’s ability to pay off its short-term debts.
Liquidity Ratios Used Alongside Current Liabilities
The following Liquidity Ratios are used in combination with Current Liabilities by accountants, investors, and financial professionals:
1. Current Ratio
The Current Ratio is also called as Working Capital Ratio. It is used by accountants, investors, lenders, suppliers, and financial professionals to evaluate a company’s overall financial health and performance. It demonstrates the company’s ability to pay off its short-term debts at any given point in time. It is commonly written in decimals. However, some individuals or companies may prefer to use the X:X pattern. A current ratio of anything above 1 or 1:1 is always favorable.
Current Ratio Formula
Current Ratio = Current Assets / Current Liabilities
2. Quick Ratio
The Quick Ratio is also called the Acid-test Ratio. It is used to get an understanding of whether the company is using its assets in such a way that it could add up to its debts than it could handle. It is especially useful for accountants while drafting budgets and understanding the financial health of the company. A Quick Ratio of anything above 1 or 1:1 is always favorable. A ratio of 1 or 1:1 indicates the company has an equal number of assets to cover up its immediate short-term debts. In contrast, a ratio of 8 or 8:1 indicates the company’s ability to pay its debts 8 times.
Quick Ratio Formula
Quick Ratio = Liquid Assets / Current Liabilities
3. Cash Ratio
The Cash Ratio is a useful measure for investors and creditors to understand a company’s ability to repay its short-term debts using both cash and near-cash resources. The near-cash resources include marketable securities, deposit certificates, money market accounts, and foreign currencies, among others. A Cash Ratio equal to or larger than 1 indicates a sound financial position and the company’s ability to pay its short-term liability. In contrast, a Cash Ratio of less than 1 indicates inadequate cash and cash equivalent, therefore risk of default.
Cash Ratio Formula
Cash Ratio = Cash & Cash Equivalents / Short-term Liabilities
Difference Between Contingent Liabilities, Current and Non Current Liabilities
Let us discuss the key differences between the three important concepts — Contingent Liabilities, Current and Non current Liabilities.
| Contingent Liabilities | Current Liabilities | Non-current Liabilities | |
| Meaning | Contingent liabilities are event-dependent liabilities that may or may not be payable depending on the future occurrence of an event. | Current liabilities are short-term liabilities that are payable within one year or one business cycle. | Non-current liabilities are long-term liabilities that are payable after one year or one business cycle. |
| Operating Cycle | Not applicable | One business cycle | More than one business cycle |
| Location | They are mentioned twice -First in the Income Statement as a Cost. -Second on the right side of the Balance Sheet. |
They are mentioned on the right side of the Balance Sheet in a separate section called “Non-current Liabilities” (above the “Non-current Liabilities” section) | They are mentioned on the right side of the Balance Sheet in a separate section called “Non-current Liabilities” (below the “Current Liabilities” section) |
| Examples | -Customer Warranty -Lawsuits -Pending Hearings -Pending Acquisitions -Tax Disputes |
-Accounts Payable -Short-term debts -Current portions of Long-term Debts -Accrued Payroll -Accrued Expenses |
-Bonds -Debentures -Mortgage Loans -Deferred Tax Liabilities -Pension Obligations |
Formula for Calculating Current Liabilities
As we’ve discussed the current liabilities meaning above, let us examine the formula for calculating Current Liabilities.
The formula for calculating the Current Liabilities is simple and straightforward. It involves the summation of all expenses that are short-term in nature (i.e. to be paid within the single business cycle).
Current Liabilities = Salaries Payable + Accounts Payable + Taxes Payable + Short-term Debts + Current Portion of Long-term Debt + Dividends Declared + Accrued Liability + Unearned Revenues
What are the Most Common Current Liabilities Examples?
The most common Current Liabilities examples include salaries payable, accounts payable, taxes payable, short-term debts, and dividends declared, among others.
1. Salaries Payable
Salaries Payable is the total outstanding amount that the business owes to its employees. It is classified as current liabilities because most businesses pay salaries on a monthly, weekly, or bi-weekly basis. For example, the company has recorded an outstanding payroll of Rs. 1,000,000 in the financial statements, but they have not been paid yet.
2. Accounts Payable
Accounts Payable are short-term debts owed by the business to external stakeholders such as suppliers and creditors. The company has received goods or services on credit, without making their payment. These debts are usually for less than 12 months. For example, purchasing machinery with an option to make payments in monthly installments.
3. Taxes Payable
Taxes Payable includes the taxes owed by the business to central, state, and local governments in the area of its operations. The amount of tax liability may vary based on the profit earned throughout the financial year, and applicable taxation rates. Since taxes must be cleared within one year, they are considered current liabilities rather than long-term liabilities.
4. Short-term Debts
A Short-term debt is a financial obligation with a tenure of less than a year. It includes short-term bank loans, lease payments, lines of credit, commercial papers, and bonds expiring within a year. For example, the company might issue commercial papers at a discount rate. Since commercial papers have a maximum validity of 270 days, they are considered a short-term debt.
5. Dividends Declared
Other current liabilities types include dividends declared but not paid. Whenever the company is in profit, it may declare a dividend as a reward for shareholders for their continued support. It is paid within one year. Since payment to shareholders reduces the company’s assets, dividends are a current liability for the business.
FAQs
1. What is the Current Liabilities Definition?
Current Liabilities meaning is that they are short-term debts that the companies own and must pay within a duration of either one year or a business cycle. These include anything from short-term debts, accused expenses, and unearned revenues to payroll liabilities.
2. What are the Three Types of Liabilities?
The three types of liabilities are Current Liabilities, Non-current Liabilities, and Contingent Liabilities. Current Liabilities are short-term liabilities whereas Non-current Liabilities are long-term liabilities. In contrast, Contingent Liabilities are event-dependent liabilities that do not have a specific time frame.
3. Why are Current Liabilities an Important Aspect of Investment Decisions?
Current liabilities are an important aspect of the company’s books of accounts. They help investors understand the liquidity level of the company, and how effectively it manages the working capital. They can also assess the company’s financial health and make strongly data-driven decisions to become profitable in the long run.
4. How are Current Liabilities Settled?
The most common way of settling Current Liabilities is through cash and cash equivalents such as current assets and marketable securities. Cash equivalents are highly liquid assets that can be converted into cash at any time. The company may also settle them with a loan or other financing.
5. Where Do Current Liabilities Appear in the Books of Accounts?
The Current Liabilities such as short-term debt, a portion of long-term loans, accrued liability, and other expenditures due within one year, are mentioned on the Liabilities side of the Balance Sheet. As items in the Balance Sheet are typically mentioned in the ascending order of their liquidity, they appear on the top of Non-current Liabilities.