Current liability definition
/What is a Current Liability?
A current liability is an obligation that is payable within one year. The cluster of liabilities comprising current liabilities is closely watched, for a business must have sufficient liquidity to ensure that they can be paid off when due. All other liabilities are reported as long-term liabilities , which are presented in a grouping lower down in the balance sheet , below current liabilities.
In those rare cases where the operating cycle of a business is longer than one year, a current liability is defined as being payable within the term of the operating cycle. The operating cycle is the time period required for a business to acquire inventory , sell it, and convert the sale into cash. In most cases, the one-year rule will apply.
Since current liabilities are typically paid by liquidating current assets , the presence of a large amount of current liabilities calls attention to the size and prospective liquidity of the offsetting amount of current assets listed on a company's balance sheet. Current liabilities may also be settled through their replacement with other liabilities, such as with short-term debt .
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The interpretation of Financial Statements
Accounting for Current Liabilities
The initial entry to record a current liability is a credit to the most applicable current liability account and a debit to an expense or asset account. For example, the receipt of a supplier invoice for office supplies will generate a credit to the accounts payable account and a debit to the office supplies expense account. Or, the receipt of a supplier invoice for a computer will generate a credit to the accounts payable account and a debit to the computer hardware asset account.
Current Liability Usage in Ratio Measurements
The aggregate amount of current liabilities is a key component of several measures of the short-term liquidity of a business, including the following:
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Current ratio . The current ratio measures the ability of an organization to pay its bills in the near-term. It is a common measure of the short-term liquidity of a business. To calculate the current ratio, divide the total of all current assets by the total of all current liabilities . The formula is:
Current assets ÷ Current liabilities = Current ratio
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Quick ratio . The quick ratio is used to evaluate whether a business has enough liquid assets that can be converted into cash to pay its bills. To calculate the quick ratio, summarize the totals for cash, marketable securities and trade receivables , and divide by current liabilities . Do not include in the numerator any excessively old receivables that are not likely to be paid, such as anything over 90 days old. The formula is:
(Cash + Marketable securities + Accounts receivable) ÷ Current liabilities = Quick ratio
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Cash ratio . The cash ratio compares a company's most liquid assets to its current liabilities . It is the most conservative of all the liquidity measurements. The formula for the cash ratio is to add together cash and cash equivalents , and divide by current liabilities. The calculation is:
(Cash + Cash equivalents) ÷ Current liabilities = Cash ratio
For all three ratios, a higher ratio denotes a larger amount of liquidity and therefore an enhanced ability for a business to meet its short-term obligations.
Examples of Current Liabilities
The following are common examples of current liabilities:
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Accounts payable . These are the trade payables due to suppliers, usually as evidenced by supplier invoices.
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Sales taxes payable . This is the obligation of a business to remit sales taxes to the government that it charged to customers on behalf of the government.
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Payroll taxes payable . This is taxes withheld from employee pay, or matching taxes, or additional taxes related to employee compensation.
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Income taxes payable . This is income taxes owed to the government but not yet paid.
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Interest payable . This is interest owed to lenders but not yet paid.
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Bank account overdrafts . These are short-term advances made by the bank to offset any account overdrafts caused by issuing checks in excess of available funding.
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Accrued expenses . These are expenses not yet payable to a third party, but already incurred, such as wages payable.
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Customer deposits . These are payments made by customers in advance of the completion of their orders for goods or services.
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Dividends declared . These are dividends declared by the board of directors, but not yet paid to shareholders.
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Short-term debt . This is loans that are due on demand or within the next 12 months.
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Current maturities of long-term debt . This is that portion of long-term debt that is due within the next 12 months.
The types of current liability accounts used by a business will vary by industry, applicable regulations, and government requirements, so the preceding list is not all-inclusive. However, the list does include the current liabilities that will appear in most balance sheets.
