What is a current liability?
Current liabilities are liabilities that are due to be fulfilled during the current fiscal year (or operating cycle). They are stated in the liabilities section of a company’s balance sheet. When a business is healthy, its current liabilities should be offset by its current assets.
Examples of current liabilities
Common examples of current liabilities include regular accounts payable and business taxes due (or anticipated) but not yet paid. This includes any income tax or insurance a business pays on behalf of its employees. If a business has declared a dividend but not yet paid it, this will also be a current liability.
In some business sectors, deferred revenue is also a typical current liability. Deferred revenue is when a customer pays in advance for a product or service that will be delivered later. These payments will also be shown as revenue on the company’s profit and loss statement.
If a company is using financing, this is likely to feed into current liabilities. If the debt is short-term, its entire cost (principal and interest) will be shown as a current liability. With long-term debt, the principal may be a long-term liability but the ongoing cost of interest payments could be included under current liabilities.
Many operating expenses (OpEX) are likely to be included in current liabilities. Capital expenditure (CapEx), by contrast, is not. CapEx usually involves significant investment and potentially long-term debt. Theoretically, however, it is possible for CapEx to be included.
Current liabilities vs long-term liabilities
In accounting, liabilities are categorized according to their due date. At a minimum, total liabilities will be split out into current liabilities and long-term liabilities. Usually, both current liabilities and long-term liabilities are further split out into more detailed categories.
Even if this is not, technically, an accounting requirement, it can be very helpful for people reading financial statements. For example, a company with current liabilities made up mostly of deferred revenue is in a very different position from a company with current liabilities made up mostly of interest payments.
Similarly, on the side of long-term liabilities, a company that has a lot of capital expenditure (such as purchasing new equipment), is in a very different position from one that is simply dealing with the cost of previous borrowing.
Valuing current liabilities
Some current liabilities will have a set cost but many will be variable. For example, debts may have variable interest rates. Employers may have to pay more income tax if employees work overtime. Companies receiving deferred revenue may incur extra costs when they fulfill their obligation to their customer.
On the one hand, companies have an obligation to predict these costs as accurately as they can. Firstly, they need to budget for them. Secondly, they often form a key element of both short-term and long-term financial planning.
On the other hand, sometimes it can be prudent just to recognize that some costs are extremely difficult to predict (and hence budget for). If this could potentially cause an issue for a company, it may be useful to take out relevant insurance.
Managing current liabilities
A business’s cash flow often depends greatly on its ability to manage its current liabilities. In simple terms, businesses need to do their best to ensure that their current assets are monetized before their current liabilities become due.
For example, many businesses want, or need, their customers to pay their invoices before they can pay their own suppliers (or possibly even their employees). Ideally, this should be achieved through robust invoicing processes and effective credit control.
It can, however, be helpful to have fallback measures in place. For example, if a customer’s payment is late then it may be possible to pay a supplier using a business credit card.
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