Current Liability Definition
A current liability is an obligation that is payable within one year. The cluster of liabilities comprising current liabilities is closely watched, for a business must have sufficient liquidity to ensure that they can be paid off when due.
All other liabilities are reported as long-term liabilities, which are presented in a grouping lower down in the balance sheet below current liabilities.
In those rare cases where the operating cycle of a business is longer than one year, a current liability is defined as being payable within the term of the operating cycle. The operating cycle is the time period required for a business to acquire inventory, sell it, and convert the sale into cash. In most cases, the one-year rule will apply.
Since current liabilities are typically paid by liquidating current assets, the presence of a large amount of current liabilities calls attention to the size and prospective liquidity of the offsetting amount of current assets listed on a company's balance sheet. Current liabilities may also be settled through their replacement with other liabilities, such as with short-term debt.
The aggregate amount of current liabilities is a key component of several measures of the short-term liquidity of a business, including:
- Current ratio. This is current assets divided by current liabilities.
- Quick ratio. This is current assets minus inventory, divided by current liabilities.
- Cash ratio. This is cash and cash equivalents, divided by current liabilities.
For all three ratios, a higher ratio denotes a larger amount of liquidity, and therefore an enhanced ability for a business to meet its short-term obligations.
Examples of Current Liabilities
The following are common examples of current liabilities:
- Accounts payable. These are the trade payables due to suppliers, usually as evidenced by supplier invoices.
- Sales taxes payable. This is the obligation of a business to remit sales taxes to the government that it charged to customers on behalf of the government.
- Payroll taxes payable. This is taxes withheld from employee pay, or matching taxes, or additional taxes related to employee compensation.
- Income taxes payable. This is income taxes owed to the government but not yet paid.
- Interest payable. This is interest owned to lenders but not yet paid.
- Bank account overdrafts. These are short-term advances made by the bank to offset any account overdrafts caused by issuing checks in excess of available funding.
- Accrued expenses. These are expenses not yet payable to a third party, but already incurred, such as wages payable.
- Customer deposits. These are payments made by customers in advance of the completion of their orders for goods or services.
- Dividends declared. These are dividends declared by the board of directors, but not yet paid to shareholders.
- Short-term loans. This is loans that are due on demand or within the next 12 months.
- Current maturities of long-term debt. This is that portion of long-term debt that is due within the next 12 months.
The types of current liability accounts used by a business will vary by industry, applicable regulations, and government requirements, so the preceding list is not all-inclusive. However, the list does include the current liabilities that will appear in most balance sheets.