Reviewed by Aug 27, 2020| Updated on
Current liabilities refer to payables or financial obligations due in the short-term, which is within a period of one year. The short-term nature depends on the operating cycle of the industry. It may be within one year or more than one year in the case of long gestation projects. Current liabilities are dependent on the working capital cycle of a company.
Understanding Current Liabilities
- The working capital cycle generates the most current liabilities including trade payables, interest on an overdraft, commission payable, marketing and other expenses. The cycle also generates current assets including trade receivables, Bank and cash in hand among others. Normally, the current liabilities are offset by the current assets. The cash flow generated from current assets is used to pay the current liabilities.
- Every organisation measures the current ratio from time to time to measure the working capital position. The current ratio is the ratio of current assets to current liabilities. A current ratio of 1 or greater than 1 indicates good working capital position of the organisation and that the organisation is able to meet all its current liabilities.
- Example of current liabilities is trade payables which are dues suppliers on account of supply of raw materials or other inputs. Companies often try to have a working capital cycle such that their cash generated from sales pays the current liabilities. The company also tries to match up the cash conversion cycle in accordance with the working capital cycle.
- To understand the method of settlement of current liabilities, a company may have payment terms of 45 days with its suppliers. However, the company may offer a 30-day credit term to its debtors. In this case, the working capital cycle enables the company to meet its trade payables comfortably.
A company’s current liabilities are often analysed with its working capital cycle and current ratio. Analysts also measure the quick ratio which indicates the ability of a company to pay its current liabilities. The quick ratio includes only those current assets which can be immediately converted into cash.