CURRENT LIABILITIES: STRUCTURE, PROTECTION RATIO, CALCULATION - DUDAS - 2025

The current liabilities, short - term or current is the set of obligations or debts of a company that mature in the course of a year or a normal operating cycle. In addition, current liabilities will be settled by using a current asset, such as cash, or by creating a new current liability.

Therefore, in accounting, current liabilities are often understood as all the liabilities of the company that will be settled in cash within the given fiscal year or operating cycle of a company, depending on which period is longer.

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Short-term liabilities appear on the company's balance sheet and include short-term debts, accounts payable, accrued liabilities, and other similar debts.

The group of liabilities that comprise current liabilities must be closely watched, as a company must have sufficient liquidity to ensure that it can be paid when required.

All other liabilities are reported as long-term liabilities, which are presented in a grouping lower on the balance sheet, below current liabilities.

Operating cycle and liquidity

The operating cycle is the period of time required for a business to acquire inventory, sell it, and convert the sale into cash. In most cases, the one-year rule will apply.

In the rare cases where a company's operating cycle lasts more than one year, a current liability is then defined as payable within the end of the operating cycle.

Since short-term liabilities are normally paid through the liquidation of current assets, the presence of a large amount in short-term liabilities should draw attention to the possible liquidity to be able to offset them against current assets on the balance sheet. the company.

Current liabilities can also be settled by replacing them with other liabilities, such as short-term debt.

Structure of current liabilities

Proper classification of liabilities provides useful information for investors and other users of financial statements. It is considered essential to allow outsiders to get a true picture of the fiscal health of an organization.

Current liabilities are reported in order of their settlement date on the balance sheet, separately before long-term debt.

Accounts payable are listed first, as are notes payable, with settlement dates closest to the current date, followed by loans to be paid later in the year.

Debts to pay

They are generally the main component of current liabilities, representing payment to suppliers within one year for purchased raw materials, as evidenced by supply invoices.

Notes payable

They are short-term financial obligations, verified by negotiable instruments such as bank loans or obligations for the purchase of equipment. They can be with or without interest.

Bank account overdrafts

These are short-term advances made by banks to offset account overdrafts due to excess funds above the available limit.

Current portion of long-term debt

The current portion of long-term debt is the portion of long-term debt that must be paid over the course of the year.

Current lease to pay

They are the obligations for rent or lease that are owed to the lessor in the short term.

Income tax to be paid

Income tax that is owed to the government, but has not yet been paid.

Accrued expenses

Expenses that have not yet been paid to a third party, but have already been incurred, such as interest and wages payable. These accumulate over time, but will nevertheless be paid when due.

For example, wages that employees have earned but not paid are reported as accrued wages.

Dividends to be paid

They are dividends declared, but have not yet been paid to shareholders. Therefore, they are recorded as current liabilities on the balance sheet.

Unearned income

They are advance payments made by clients for future work to be completed in the short term, such as an advance subscription to a magazine.

Ratio of protection to current liabilities

This reason constitutes the guarantee or protection that the owners of the company provide to their creditors of short-term debts.

The current liability protection ratio is given by the following formula: tangible stockholders' equity / current liabilities.

This reason is generally used to establish the protection or guarantee that the credit granted by short-term creditors has. The standard practical reasons established for the different types of company are:

- Retail business companies: 1.25.

- Banks or financial companies: -2.

- Industrial companies: 1.5.

Analysis

When comparing the standard practical reasons against the real ones, if the former are lower, it can be thought that the company is supposedly in a good financial position.

On the other hand, if the standard practical reasons are higher than the real ones, it can be thought that the equity has a poor solidity. In fact, when the actual ratio is less than unity, it can be said that the company is in the hands of creditors.

Creditors and analysts often use the current ratio (current assets divided by current liabilities), or the quick ratio (current assets minus inventory, divided by current liabilities), to determine whether a company can pay its short-term liabilities.

One application of this is found in the current ratio. A ratio greater than 1 means that current assets, if all can be converted to cash, are more than enough to pay current liabilities.

Higher values ​​for this ratio imply that it will be easier for a company to meet its obligations throughout the year.

How current liabilities are calculated

When a company determines that it received an economic good that must be paid for in the course of a year, it must record a credit entry in current liabilities.

Depending on the nature of the good received, it will be classified as an asset or as an expense.

Classification as an asset

For example, a large automaker receives a shipment of exhaust systems from its supplier, to whom it must pay $ 10 million in the next 90 days.

Because these materials are not immediately put into production, there is a credit entry to accounts payable and a debit entry to inventory for $ 10 million.

When the company pays the balance due to the supplier, then it debits the accounts payable and credits the cash account with $ 10 million.

Classification as an expense

Suppose a company receives a tax preparation service from its external auditor, and must pay $ 1 million for it in the next 60 days.

The company's accountant records a debit entry of $ 1 million to the audit services expense account and a credit entry of $ 1 million to the other current liabilities account.

When the payment of $ 1 million is made, a debit entry of $ 1 million is made to the other current liabilities account and a credit of $ 1 million to the cash account.

Formula calculation

The formula for calculating current liabilities is quite simple. It is simply the sum of all the current liabilities of the company.

Some current liabilities are: notes payable, accounts payable, accrued expenses, unearned income, current portion of long-term debt, and other short-term debt. Mathematically, the formula for current liabilities is represented as:

Current liabilities = notes payable + accounts payable + accrued expenses + unearned income + current portion of long-term debt + other short-term debt.

Calculation of average current liabilities

The average current liabilities of a company refers to the average value of short-term liabilities, from the initial period of the balance sheet to its final period.

To calculate average current liabilities for a particular period, you add the total value of current liabilities on the balance sheet at the beginning of the period with their total value at the end of the period, and then divide by two. The formula for average current liabilities is as follows:

(Total current liabilities at the beginning of the period + total current liabilities at the end of the period) / 2

Difference with current assets

When analyzing the balance sheet of a company, it is important to know the difference between current assets and current liabilities.

Resources vs. obligations

Current assets are the short-term resources of a company, either in cash or cash equivalents, that can be settled over the course of twelve months or within an accounting period.

Current liabilities are the short-term obligations of a company, which are expected to be settled in the course of twelve months or within an accounting period.

Conversion or liquidation

Current assets will be converted to cash or consumed during the accounting period.

Current liabilities will be canceled with current cash or bank assets. That is, they are settled through current assets, or through the entry of new current liabilities.

Liquidity

An important difference between current assets and current liabilities related to business liquidity is that when the amount of current assets is higher this will mean high working capital, which in turn means high liquidity for the business.

On the other hand, when the amount of current liabilities is higher this will mean low working capital, which translates into low liquidity for the business.

Placing on the balance sheet

Current assets are placed on the assets side of a balance sheet, in the order of their liquidity.

Current liabilities are placed on the liability side of a balance sheet. Typically, the main portion of the notes payable is shown first, then the accounts payable and the remaining current liabilities last.

Working capital

The difference between current assets and current liabilities is known as working capital, which represents the operational liquidity available to companies.

To ensure that a company is able to carry out its business, positive working capital and the possession of adequate funds are needed to be able to satisfy short-term debts as well as future operating expenses.

Working capital is a measure of the liquidity, operating efficiency, and short-term financial health of a business. If a company has substantial working capital, then it should have the potential to invest and grow.

If a company's current assets do not exceed its current liabilities, then the company may have trouble growing or paying creditors, or even going bankrupt.

Examples of current liabilities

Examples of current liabilities vary by industry or by different government regulations.

- Accounts payable: is the money owed to suppliers. They represent unpaid supplier invoices.

- Accrued expenses: this is money that is owed to a third party, but is not yet payable. For example, wages to be paid.

- Overdrafts in bank accounts: these are short-term advances made by the bank for overdrafts.

- Bank loans or promissory notes: they are the main circulating part of a long-term note.

- Notes payable (other than bank notes): they are the main current part of long-term notes.

- Short-term Notes Payable: These loans are due within the next year.

- Customer deposits or unearned income: these are payments made by customers as an advance for future work, which is expected to be completed during the next 12 months.

- Interest payable: it is the interest owed to the lenders, which has not been paid.

Other examples

- Rent payments: are payments owed for the rental of buildings, land, or other properties or structures.

- Income taxes payable: are taxes owed to the government that have not yet been paid.

- Dividends payable: are dividends declared by the company's board of directors, which have not yet been paid to shareholders.

- Sales taxes payable: are taxes charged to customers, which must be paid to the government.

- Payroll Taxes Payable: Taxes withheld from employees or taxes related to employee compensation.

An account called "other current liabilities" is often used as a global item on the balance sheet to include all other liabilities due in less than one year and not classified elsewhere.

References

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6. My Accounting Course (2019). What is a Current Liability? Taken from: myaccountingcourse.com.
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