Current (or short-term) liabilities are liabilities that a company is required to settle within the next twelve months or which it expects to settle within its normal operating cycle.
Liabilities are financial obligations which require transfer of assets (mainly cash) for settlement. They are classified into current and non-current liabilities based on the urgency of their settlement. Comparison of current liabilities with current assets helps creditors, debt-holders and investors assess a company’s liquidity position.
Here is a list of typical current liabilities:
- Accounts payable
- Salaries payable
- Short-term debt payable
- Short-term notes payable
- Current lease liability
- Interest payable
- Current tax payable
- Accrued expenses
- Dividends payable
Accounts payable, salaries payable, accrued expenses and current tax payable are classified as current liabilities because they are expected to be paid off within a normal operating cycle. These liabilities are reported as current even if the company expects them to be paid after 12 months.
Short-term debt payable, short-term notes payable and current lease liability represent that portion of the relevant long-term liability which is due within next 12 months.
Interest payable is normally a current liability because it is due with 12 months.
Dividends payable is a current liability because corporate laws normally require them to be paid within a certain period after declaration date.
Classify the following liabilities of STU, Inc. into current and non-current as at 31 August 2015:
- Trade payables of $220 million (of which $20 million are due on 15 October 2016)
- Salaries payable of $45 million
- Pension liability of $550 million (of which $10 million is payable within next 12 months)
- Current tax payable of $12 million
- Net deferred tax liability of $22 million
- Total lease liability of $25 million (of which $4 million is the current portion of finance lease and $3 million is related to operating lease payable within 12 months)
- Dividends of $15 million declared on 14 August 2015 to be paid on 14 September 2015.
- Long-term loan payable to banks of $500 million (of which $120 million is due in next 12 months which the company can’t reschedule on its own)
- Notes payable of $40 million (10 million due within 12 months)
If the company’s total assets and non-current assets are $1,910 million and $1,400 million, demonstrate how information about current liabilities help better assess liquidity and solvency of a company.
All amount are USDs in million
|a||220||220||0||Trade payable is a current liability even if payable after 12 months.|
|b||45||45||0||Salaries are due to be paid in a normal operating cycle|
|c||550||10||540||Pension payable is a non-current liability except the current portion.|
|d||12||12||0||Current tax is payable within normal operating cycle|
|e||22||0||22||Accounting standards such as IFRS always classify deferred tax liability as non-current.|
|f||25||7||18||Current portion = current portion of finance lease + current operating lease rentals|
|g||15||15||0||Dividends are expected to be paid within 12 months|
|h||500||120||380||$120 million is the current portion because it is 'unconditionally' due within 12 months.|
|i||40||10||30||The amount due with in 12 months is classified as current.|
STU, Inc. current assets = total assets – non-current assets = $1,910 million – $1,400 = $510 million
Since current liabilities are $439 million against current assets of $510 million, the current ratio is 1.16. It means that the company has enough current assets (i.e. assets that are due to be converted to cash in next 12 months) to pay-off its short-term liabilities.
Solvency is assessed by debt ratio which compares total assets with total liabilities. In case of STU, Inc., debt ratio is 0.75 (= $1,429/$1,910) which shows that 75% of the company’s assets are financed by debt and hence total assets are adequate to pay off liabilities in case of a crisis.
Information about timing of cash inflows and cash outflows is very critical particularly in the short-term which is why liabilities and assets are categorized into current and non-current portion to assess the financial position both in the short-term and long-term.