A liability is an obligation to pay or provide future services for something that has been in turn provided or agreed upon in the past. There are two main types of liabilities: current liabilities and long-term liabilities. Show
Current liabilitiesA current liability is one the company expects to pay in the short term using assets noted on the present balance sheet. Typical current liabilities include accounts payable, salaries, taxes and deferred revenues (services or products yet to be delivered but for which money has already been received). On the financial statement, information about the solvency of a company can be determined through assessing its liabilities and its ability to settle those obligations. Long-term liabilitiesA long-term liability is one the company expects to pay over the course of more than one year. Long-term liability is usually formalized through paperwork that lists its terms such as the principal amount involved, its interest payments, and when it comes due. Typical long-term liabilities include bank loans, notes payable, bonds payable and mortgages. Read next: Reading a financial statement: The balance sheet (assets, liabilities and equity)ReferencesMarkle, K. (2004, August). Introduction to Accounting. Presentation delivered at Schulich School of Business, York University, Toronto, Canada. Current, non-current and contingent liabilities There are three primary types of liabilities: current, non-current, and contingent liabilities. Liabilities are legal obligations or debt owed to another person or company. In other words, liabilities are future sacrifices of economic benefits that an entity is required to make to other entities due to past events or past transactions. Defined by the International Financial Reporting Standards (IFRS) Framework: “A liability is a present obligation of the enterprise arising from past events, the settlement of which is expected to result in an outflow from the enterprise of resources embodying economic benefits.”  Classification of LiabilitiesThese are the three main classifications of liabilities:
Types of Liabilities: Current LiabilitiesCurrent liabilities, also known as short-term liabilities, are debts or obligations that need to be paid within a year. Current liabilities should be closely watched by management to ensure that the company possesses enough liquidity from current assets to guarantee that the debts or obligations can be met. Examples of current liabilities:
Current liabilities are used as a key component in several short-term liquidity measures. Below are examples of metrics that management teams and investors look at when performing financial analysis of a company. Examples of key ratios that use current liabilities are:
Types of Liabilities: Non-current LiabilitiesNon-current liabilities, also known as long-term liabilities, are debts or obligations due in over a year’s time. Long-term liabilities are an important part of a company’s long-term financing. Companies take on long-term debt to acquire immediate capital to fund the purchase of capital assets or invest in new capital projects. Long-term liabilities are crucial in determining a company’s long-term solvency. If companies cannot repay their long-term liabilities as they become due, the company will face a solvency crisis. List of non-current liabilities:
Types of Liabilities: Contingent LiabilitiesContingent liabilities are liabilities that may occur, depending on the outcome of a future event. Therefore, contingent liabilities are potential liabilities. For example, when a company is facing a lawsuit of $100,000, the company would incur a liability if the lawsuit proves successful. However, if the lawsuit is not successful, then no liability would arise. In accounting standards, a contingent liability is only recorded if the liability is probable (defined as more than 50% likely to happen). The amount of the resulting liability can be reasonably estimated. Examples of contingent liabilities:
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Current Liabilities on the balance sheet refer to the debts or obligations that a company owes and is required to settle within one fiscal year or its normal operating cycle, whichever is longer. These liabilities are recorded on the Balance Sheet in the order of the shortest term to the longest term. The definition does not include amounts that are yet to be incurred as per the accrual accountingAccrual Accounting is an accounting method that instantly records revenues & expenditures after a transaction occurs, irrespective of when the payment is received or made. read more. For example, the salary to be paid to employees for services in the next fiscal yearFiscal Year (FY) is referred to as a period lasting for twelve months and is used for budgeting, account keeping and all the other financial reporting for industries. Some of the most commonly used Fiscal Years by businesses all over the world are: 1st January to 31st December, 1st April to 31st March, 1st July to 30th June and 1st October to 30th Septemberread more is not yet due since the services have not yet been incurred. List of Current LiabilitiesA list of current liabilities are as follows: You are free to use this image on your website, templates, etc, Please provide us with an attribution link Article Link to be HyperlinkedFor eg: Source: Current Liabilities (wallstreetmojo.com) #1 – Accounts PayableAccounts PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more is usually the major component representing payment due to suppliers within one year for raw materials bought, as evidenced by supply invoices. Here is the example We note from above that Accounts Payable of Colgate is $1,124 million in 2016 and $1,110 million in 2015. #2 – Notes Payable (Short-term)- Notes PayableNotes Payable is a promissory note that records the borrower's written promise to the lender for paying up a certain amount, with interest, by a specified date. read more are short-term financial obligations evidenced by negotiable instrumentsA negotiable instrument refers to the transferrable and signed written document whereby the payer guarantees or promises to pay a certain sum on a specific future date or as on-demand to the payee or bearer. It includes bills of exchange, delivery order, promissory note, customer receipt, etc.read more like bank borrowings or obligations for equipment purchases. Maybe interest bearing or non-interest bearing. Notes and loans payable for Colgate are $13 million and $4 million in 2016 and 2015, respectively. #3 – Bank Account OverdraftsShort term advances made by the banks to offset accountOffset account is an account which is directly or indirectly related to another account. It reduces the balance of the related account to give us a net balance which is used for calculation, valuation, interpretation, and application in financial statements as the requirement may arise in the course of business and statutory requirements.read more overdrafts due to excess funding above the available limit. Also, have a look at the revolving credit facilityA revolving credit facility refers to a pre-approved loan facility provided by banks to their corporate clients. It states that the companies are free to borrow funds from these financial institutions to fulfill their cash flow needs by paying off the underlying commitment fees.read more #4 – Current portion of long-term debtCurrent portion of long-term debtCurrent Portion of Long-Term Debt (CPLTD) is payable within the next year from the date of the balance sheet, and are separated from the long-term debt as they are to be paid within next year using the company’s cash flows or by utilizing its current assets.read more is a part of the long-term debt due within the next year #5 – Current Lease payable-Lease obligations due to the lessorA lessor is an individual or entity that leases out an asset such as land, house or machinery to another person or organization for a certain period.read more in the short-term Facebook SEC Filings Facebook’s current portion of the capital lease was $312 million and $279 in 2012 and 2011, respectively. #6 – Accrued Income Taxes or Current tax payableIncome Tax owed to the government but not yet paid We note from above that Colgate’s accrued income tax was $441 million and $277 million, respectively. #7 – Accrued Expenses (Liabilities)Expenses not yet payable to the third party but already incurred like interest and salary payableSalary payable refers to the liability of the company towards its employees against the amount of salary of a period that became due but has not been paid yet to them by the company and it is shown in the balance of the company under the head liability.read more. These accumulate with time. However, they will get paid when they become due. For example, salaries that the employees have earned but not been paid are reported as accrued salaries. Facebook’s accrued liabilitiesAccrued liabilities refer to the obligations against expenses which the company incurs over one accounting period; however, it has not made any monetary payment for such expenses in the same accounting period. These expenses appear as liabilities in the corporate balance sheet.read more are at $441 million and $296 million, respectively. #8 – Dividend Payable-Dividends payables are Dividend declaredDividend declared is that portion of profits earned that the company’s board of directors decides to pay off as dividends to the shareholders of such company in return to the investment done by the shareholders through the purchase of the company’s securities.read more, but yet to be paid to shareholders. #9 – Unearned Revenue-Unearned revenuesUnearned revenue is the advance payment received by the firm for goods or services that have yet to be delivered. In other words, it comprises the amount received for the goods delivery that will take place at a future date.read more are advance payments made by customers for future work to be completed in the short term like an advance magazine subscription. The below example details of unearned subscription revenues for a Media (magazine company) You are free to use this image on your website, templates, etc, Please provide us with an attribution link Article Link to be HyperlinkedFor eg: Source: Current Liabilities (wallstreetmojo.com) How to analyze?Current liabilities on the balance sheet impose restrictions on the cashRestricted cash is the portion of cash that has been set aside for a specific purpose. It is usually held in a special account (for example, an escrow account) so it remains separate from the rest of a business’ cash and equivalents.read more flow of a company and have to be managed prudently to ensure that the company has enough current assets to maintain short-term liquidity. In most cases, companies are required to maintain liabilities for recording payments which are not yet due. Again, companies may want to have liabilities because it lowers their long-term interest obligation. Some of the essential ways you can analyze them are 1) Working Capital and 2) Current Ratios (& Quick Ratio) #1 – Working CapitalWorking capital is the capital that makes fixed assetsFixed assets are assets that are held for the long term and are not expected to be converted into cash in a short period of time. Plant and machinery, land and buildings, furniture, computers, copyright, and vehicles are all examples.read more work in an organization. Working capital can be calculated as follows: Working Capital formulaWorking capital is the amount available to a company for day-to-day expenses. It's a measure of a company's liquidity, efficiency, and financial health, and it's calculated using a simple formula: "current assets (accounts receivables, cash, inventories of unfinished goods and raw materials) MINUS current liabilities (accounts payable, debt due in one year)"read more = Current Assets – Current Liabilities #2 – Current Ratio & Quick RatioCurrent Liabilities on the balance sheets are also used to calculate liquidity ratios like the current ratio and quick ratio. These ratios are calculated as follows: Current Ratio= Current Assets (CA) /Current Liabilities (CL) and Quick Ratio= (CA- Inventories)/CL
Why Are Current Liabilities higher in the Retail Industry?For the retail industry, the current ratio is usually less than 1, meaning that current liabilities on the balance sheet are more than current assetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more. As we note from above, Costco’s Current Ratio is 0.99, Walmart’s Current ratio is 0.76, and that of Tesco is 0.714. ConclusionMost Balance sheets separate current liabilities from long-term liabilities. It gives an idea of the short-term dues and is essential information for lenders, financial analysts, owners, and executives of the firm to analyze liquidity, working capital managementWorking Capital Management refers to the management of the capital that the company requires for financing its daily business operations. It is important for the company in order to maximize its operational efficiency, manage its short term liabilities and assets properly, avoiding the underutilization of the resources and avoiding the overtrading, etc.read more, and compare across firms in the industry. Being part of the working capital is also significant for calculating free cash flow of a firm. Although it is more prudent to maintain the current ratio and a quick ratio of at least 1, the current ratio greater than one provides an additional cushion to deal with unforeseen contingencies. Traditional manufacturing facilities maintain current assetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more at levels double that of current liabilities on the balance sheet. However, the increased usage of just in time manufacturing techniques in modern manufacturing companies like the automobile sector has reduced the current requirement. Current Liabilities VideoRecommended ArticlesThis article is a guide to what is Current Liabilities and its definition. Here we provide the list of current liabilities along with practical examples and best ways to analyze current liabilities, the working capital, and the liquidity ratios like current and quick ratios. You may also have a look at these following recommended articles on accounting basics – |
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