A debt with a one-year payoff period is referred to as a current liability. Current obligations are regularly monitored since a company needs to have enough liquidity to ensure that they can be paid off when they are due. The balance sheet's lower section, below current liabilities, groups all other obligations together as long-term liabilities.
A current liability is one that must be paid back within the operational cycle of the business, which only happens in extremely rare circumstances when it is longer than a year. The amount of time needed for a business to buy merchandise, sell it, and turn the proceeds into cash is known as the operating cycle. The one-year rule will typically be in effect.
Accounting for Current Liabilities
A credit is made to the current obligation account that best fits the situation, while a debit is made from an expense or asset account. As an illustration, receiving an office supply supplier invoice will result in a credit to the accounts payable account and a debit to the office supply expense account. Alternatively, a credit will be made to the accounts payable account and a debit will be made to the computer hardware asset account upon receipt of a supplier invoice for a computer.
Current Liability Usage in Ratio Measurements
The total amount of a company's current liabilities plays a significant role in a number of indicators of its short-term liquidity, such as:
- Current Ratio - This is the product of current liabilities and current assets.
- Quick Ratio - This is current liabilities divided by current assets less inventory.
- Cash Ratio - By current liabilities, cash and cash equivalents are separated.
The ability of the business to meet its short-term obligations is increased when any of the three ratios has a larger ratio. This implies better liquidity.
Examples of Current Liabilities
Common instances of current obligations include the following:
- Accounts Payable - These are the supplier trade payables, which are typically supported by supplier invoices.
- Sales Taxes Payable - It is the responsibility of the business to pay the government the sales taxes it collected from customers.
- Payroll Taxes Payable - This applies to both the taxes that are withheld from employee salaries and any matching or additional taxes.
- Income Taxes Payable - These are unpaid income taxes owed to the government.
- Interest Payable - This is unpaid interest that is owing to lenders.
- Bank Account Overdrafts - These are quick loans that the bank gives out to cover any account overdrafts brought on by writing checks that are larger than the money they have on hand.
- Accrued Expenses - These are costs that have already been incurred but are not yet due to a third party, like wages that must be paid.
- Customer Deposits - These are payments made by clients before their requests for products or services are fulfilled.
- Dividends Declared - Clients make these payments in advance of receiving the goods or services they have requested.
- Short-Term Debt - These are loans that must be repaid immediately or within the upcoming 12 months.
- Current liabilities are the short-term debt obligations of a business that are due within a year or during a typical operational cycle.
- Current assets, or assets that are exhausted within a year, are frequently used to pay off current liabilities.
- Some instances of current liabilities consist of accounts payable, short-term debts, unpaid income taxes, notes payable, and dividends.
- The analysis of current obligations is essential for both investors and creditors. This could provide insight into the financial health and current liabilities management of a company.