Current liabilities, also known as short-term liabilities, are the summation of a company’s debts, financial obligations, and accrued expenses that appear on its balance sheet and are due within twelve months. Examples of current liabilities include accounts payable, short-term loans, accrued expenses, taxes payable, unearned revenues, and current portions of long-term debt.
Current Liabilities Formula
It is relatively simple to calculate a company’s current liabilities. What’s important here is to ensure that all relevant items are included in the calculation. We will show the formula for calculating the current liabilities and discuss each of the components below.
The current liabilities formula is:
(Notes Payable) + (Accounts Payable) + (Short-Term Loans) + (Accrued Expenses) + (Unearned Revenue) + (Current Portion of Long-Term Debts) + (Other Short-Term Debts)
Notes payable is a liability that represents the total amount of promissory notes that a company has issued but not yet paid. It is reported as a current liability when it is due within a year of the balance sheet date. Notes payable that are not due within one year are considered a long-term debt or non-current liability.
Accounts payable are a company’s short-term financial obligations to its suppliers or creditors. Accounts payable are usually for purchases of goods and services on credit. Accounts payable have a credit balance on the balance sheet that will be debited once settled. They typically reflect vendor invoices that have been approved and processed but have not yet been paid.
Short-term loans are loans that must be repaid within a period of one year or less. Short-term loans also include business lines of credit that have been drawn down and are due within the next 12 months. There are various reasons why a business needs short-term business loans – such as funding for short-term working capital needs, funding for a new product launch, or to fill temporary cash flow gaps.
Accrued expenses are expenses that are recorded on a company’s balance sheets before they are paid. They are considered current liabilities because they are typically due within one year or less. Accrued expenses are usually periodic and recurring expenses such as salaries and wages, utilities, rent expense, interest expense, and more.
Unearned revenue is a current liability that represents cash received in advance from customers before providing the goods or services. This is typically a prepayment for something that a company is expected to produce within one year or less. One example for this is a gift check or gift card, which was purchased in advance before the goods or services are delivered.
Current Portions of Long-Term Debts
The current portions of long-term debts equal amount of a long-term loan’s principal that will be due within twelve months of the balance sheet date. For example, a company might have total outstanding commercial real estate and SBA loans payable of $300,000. Assuming that the principal payments due within one year is $30,000, this $30,000 is reported as a current liability. The remaining $270,000 is reported as a long-term liability.
Other debts and payables include all other short-term liabilities that are payable within one year. This may include – but are not limited to – credit card debts, sales taxes payable, payroll taxes payable, dividends, customer deposits, bank overdrafts, salaries payable, and rent expense.
How to Calculate Average Current Liabilities
A company’s current liabilities are shown on its balance sheet. A company’s average current liabilities refer to the average value of a company’s short-term liabilities from the beginning balance sheet period to its ending period.
To calculate the average current liability for a particular period, simply add the total value of current liabilities on the balance sheet for the beginning of the period to its total value at the end of the period, and then divide by 2. Below is the average current liabilities formula:
(Total current liabilities at the beginning of the period + Total current liabilities at the end of the period) / 2
Why is it Important to Track Your Current Liabilities?
Your current liabilities gives you a general overview of your business’s short-term financial standing and is good when planning for working capital expenditures. Generally, a company that has fewer current liabilities than current assets is considered to be healthy.
Ideally, the ratio of your current assets to your current liabilities should remain between 1.2 to 2. However, current liabilities aren’t necessarily a bad thing. For example, taking on short-term debt to fund growth can be a net positive. For more information, you can read our guides on the current ratio and the quick ratio.
Current liabilities are a key component in establishing a company’s short-term liquidity. In order for liabilities to be classified and reported as current liabilities on a company’s balance sheet, the items must be due within one year. In general, a financially healthy company has more current assets than they have current liabilities, or with a current ratio of between 1.2 to 2.