What Are Current Liabilities?
Current liabilities are obligations to the firm which must be settled within the greater of one year or an operating cycle.
Typical current liabilities include accounts payable (also called trade payables), current portion of long-term debt, and taxes (income, sales, payroll) payable.
Current liabilities are presented on the balance sheet before long-term liabilities.
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Why Current Liabilities Matter
Current liabilities are important to creditors, who are concerned with the firm’s ability to satisfy its current liabilities out of current assets and operating cash flow.
Creditors often monitor current liabilities as a percentage of current assets. All else equal, the higher the ratio of current liabilities to current assets, the lower the firm’s credit quality.
Conversely, creditors prefer to see a high ratio of current assets to current liabilities (the ratio of current assets to current liabilities is simply the inverse of the ratio of current liabilities to current assets).
Creditors calculate and review various credit ratios involving current liabilities.
Current ratio formula is used to evaluate a company’s ability to meet short-term liabilities.
Operating and Financing Current Liabilities
Like current assets, current liabilities can be broken into operating current liabilities and financial current liabilities.
Operating current liabilities are those current liabilities that correspond to the firm’s operating activities. The most common operating liabilities are trade payables and accrued expenses.
Financing current liabilities are those liabilities that correspond to the firm’s financing activities. Common financing current liabilities include short term debt and the current portion of long-term debt.
Example of Current Liabilities
Consider a company preparing its balance sheet at the end of an accounting period.
The company reports the following liabilities:
Accounts payable: $40,000
Accrued expenses: $10,000
Current portion of long-term debt: $20,000
Taxes payable: $5,000
These obligations must be settled within the next year or operating cycle, so they are classified as current liabilities on the balance sheet.
The company’s total current liabilities equal $75,000.
Creditors and analysts often compare this number to current assets to evaluate the company’s short-term liquidity and ability to meet its obligations.
Key Takeaways
- Current liabilities are frequently compared to current assets when evaluating liquidity and credit quality.
- Current liabilities are obligations that must be settled within one year or the operating cycle.
- Common current liabilities include accounts payable, accrued expenses, short-term debt, and taxes payable.
- Current liabilities appear before long-term liabilities on the balance sheet.
- Creditors closely monitor current liabilities because they indicate a company’s short-term obligations.