Companies operate through funds gathered from various sources. Usually, these funds come from two sources, including equity and debt. Equity finance is one of the most prominent finance sources for companies. For businesses, it includes any capital invested by the owners. For companies, on the other hand, it consists of share capital and other reserves. Apart from these, profits also become a part of equity finance.
Equity finance is one of the most common finance sources for companies. However, it may come with higher costs to a company. Instead of equity finance, companies may also choose debt finance. While this finance comes from third parties, it can be cheaper. However, it comes with its disadvantages. The primary return provided on this finance is the interest paid on the funds acquired.
The primary source of debt finance is financial institutions, such as banks and lenders. However, companies can also obtain this finance from other sources. Usually, companies can divide this finance under long- and short-term activities. While long-term finance comes from similar institutions, short-term finance may differ. This finance also falls under current liabilities in the balance sheet.
What are Current Liabilities?
Liabilities, in general, are debt obtained from third parties. In accounting, it includes any obligations from past events. These obligations result in an outflow of economic benefits in the future. Essentially, liabilities are amounts that companies must settle through a transaction in the future. This transaction usually occurs through cash or other forms of compensation. Liabilities are also a crucial part of the balance sheet.
Accounting standards require companies to divide their liabilities based on the due date. They entail separating obligations that fall within a year from others. In accounting, any liabilities that companies must settle within the next 12 months fall under current liabilities. On the other hand, any amounts payable after that become a part of non-current liabilities. Together, these amounts form the total liabilities on the balance sheet.
Therefore, current liabilities are obligations that companies must settle within a year. In other words, these require a settlement in the next 12 months. However, the definition for current liabilities may not provide an accurate picture of what it includes. The above description only covers what accounting standards constitute as current liabilities. In practice, however, it may contain various figures.
For companies, current liabilities include short-term debt that they must repay within 12 months. This debt comes from third parties. Like long-term debt, current liabilities do not usually originate from financial institutions. In some cases, companies may also obtain short-term borrowings that become a part of this heading. Apart from these, other figures may come from other parties, such as suppliers.
Overall, current liabilities are obligations that require settlement within the next 12 months. This division between liabilities comes from accounting standard requirements. Consequently, companies must identify any debts repayable within a year. These figures then fall under different headings in the balance sheet. Usually, some prevalent items appear in the balance sheet under current liabilities.
What are the Examples of Current Liabilities?
Current liabilities include all obligations that companies expect to settle in 12 months. The word “expect” plays a crucial role in this definition. Sometimes, obligations may last more than 12 months. However, they may still appear under current liabilities if companies expect a settlement within a year. This definition makes it difficult to predict the items that companies must classify as current liabilities.
However, some prevalent items appear under current liabilities for most companies. Some examples of current liabilities on the balance sheet include the following.
Accounts payable is one of the most prominent items falling under current liabilities. It represents the amount owed to suppliers due to past purchases. Usually, accounts payable are part of trade payable for companies. In most cases, companies expect to settle these amounts within a year. Practically, these amounts last for 1-2 months based on the credit terms offered by suppliers. Accounts payable are one of the most common examples of current liabilities.
Principle and interest payable
Companies acquire loans from various sources, which constitutes debt finance. However, these loans do not have a lump-sum repayment date. Instead, companies must repay them in sizeable portions based on the contract with the lender. Accounting standards require companies to separate the current portion of the principle and interest payable for those loans. These amounts then appear under current liabilities.
Short-term borrowings also appear commonly on the balance sheet under current liabilities. Unlike loans, these borrowings last for a few months. Some of them may also require companies to repay within a year. Nonetheless, these amounts fall under the current liabilities in the balance sheet. Any loans that companies expect to settle after a year will fall under non-current liabilities.
The accrual concept in accounting requires companies to record expenses when they occur. This treatment creates liability when recording those expenses before settlement. In accounting, this liability is called accrued expenses. Accrued expenses usually include amounts payable to vendors for short-term obligations. For example, they may consist of rent, utilities, salaries payable, etc.
Companies must calculate their taxes and record them in the income statement every year. This treatment also comes due to the requirement of the accrual concept. Usually, companies increase their tax expense while creating a liability. When they pay taxes, they can reduce the obligation. Usually, companies pay taxes each year. Therefore, taxes payable fall under current liabilities.
Deferred revenues are not as prevalent as the above items. However, they are common for companies that collect advances from customers. Deferred revenues are amounts from customers paid in advance for future sales. Companies cannot record these amounts as revenues as they do not involve an underlying sale. Once they sell a product to the customer, companies can remove it from current liabilities.
How Do Most Companies Pay Current Liabilities?
Companies may settle current liabilities in many ways. Usually, companies generate revenues from their operations, which constitute income. These revenues help companies profit from their operations. Consequently, companies use those profits to settle debts. These may not be sufficient to cover long-term debts, though. Therefore, profits make a great option to settle current liabilities.
Companies may also use their long-term debts to cover short-term debts. Usually, short-term liabilities fall under a company’s working capital management policies. Companies acquire current liabilities to fund short-term operations. Once they finance those operations, they can pay the debt with long-term liabilities. Nonetheless, it is a part of a company’s debt policies. Companies must also use long-term debt sparingly when settling short-term liabilities.
Another prevalent method most companies use to pay current liabilities is equity. Like current liabilities, equity is a finance source. When settling current liabilities, companies may use that source to repay vendors. However, equity finance is significantly more expensive than other sources. Therefore, companies must ensure it is practical to settle current liabilities through equity.
Usually, companies pay current liabilities through cash and bank balances. These sources include money commonly used to settle debts. However, cash isn’t the only way to repay current liabilities. Companies can also pay current liabilities through other compensation channels. For example, companies can settle deferred revenues by selling products or services to customers.
Current liabilities include short-term obligations that companies must settle within a year. These amounts appear on the balance sheet under a separate heading. In accounting, dividing liabilities into current and non-current portions are mandatory. Most companies pay current liabilities through other finance sources. Usually, these settlements occur through cash or bank balances. However, companies may also use other forms of compensation.