Understanding current liabilities

In the world of accounting, liabilities, quite simply, are a company’s financial obligations - anything that is owed (usually a sum of money) to banks, suppliers, lenders or employees. Every firm has them - that’s a fact. Liabilities are central to running your business. In this article, we answer these common questions: what are current liabilities, what are non-current liabilities and how do they work?

What are current liabilities?

Current liabilities, also known as short-term liabilities, are liabilities that are due within one year. So, what are non-current liabilities then? Unsurprisingly, non-current liabilities, or long-term liabilities, are liabilities that are due after a year or more. You also have contingent liabilities, which are liabilities that may or may not arise, depending on the outcome of a certain event, for example, lawsuits or product warranties. Pretty straightforward, right?

How do current liabilities work?

Your business’s balance sheet can be divided into two categories: assets and liabilities. Assets are what you own and liabilities are what you owe. Assets add value to your company, while liabilities decrease your company’s value. They work hand in hand.

Liabilities are usually settled using your current assets, which are assets that are used up within a year - commonly cash or accounts retrievable. When it comes to determining a company’s ongoing ability to pay debts as they are due, analysts and creditors will look at the ratio of current assets to current liabilities. This is called the current ratio. It is calculated by dividing current assets by current liabilities. You may find that the quick ratio is used, which is the same formula as the current ratio, but the value of total inventories is subtracted beforehand.

Current liabilities examples

These are some of the most common current liabilities found on the balance sheet:

• Accounts payable: When a company purchases goods or services on credit, the current liability accounting entry is known as accounts payable. Essentially, it’s the money owed to third parties, such as suppliers, vendors and creditors. Managing accounts payable is integral to control your business’s cash flow.

• Payroll: If you’ve set up a business and are employing people, you will need payroll. Payroll refers to the process of calculating your employees’ pay. It is used to calculate net/gross pay, Statutory Sick Pay (SSP), National Insurance (NI) and pension payments. All of this information is recorded in a payslip, a document to summarise earnings and deductions, which is given to your employees once they have been paid.

• Short-term debt: Perhaps the most obvious form of current liabilities is short-term debt. This could include anything from short-term bank loans to utility bills, credit card charges

• Dividends: A dividend is the distribution of some of a publicly-listed company’s profits to shareholders, people who own shares in the company. These payments work as rewards to investors for putting their money into the venture.

• Taxes payable: The taxes payable account refers to the amount of money a company owes in taxes. The main small business taxes in the UK are income tax, national insurance contributions, corporation tax, VAT and business rates.

Accrued expenses, notes payable, unearned revenue and interest payable are some additional current liabilities examples. On the contrary, non-current liabilities include long-term longs, bonds payable, deferred tax liabilities, mortgage payable and capital leases.

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