Financial Explainer — current liabilities

For many small business owners, financial accounts can sometimes seem like a black hole. As small business advisors, our aim is to help companies understand this aspect of their business.

In this blog, which is part of a series, we're going to cover your current liabilities — what they are and why you need to understand them.

Current liabilities are the debts your business owes and must pay, usually within a year.

They're in a sense the opposite to current assets, i.e. what your business owns that can be converted to cash (through liquidation, use or sales), typically within a year.

In case you're unaware, your balance sheet is split into two parts. It comprises your assets on one side and your liabilities and equity on the other. As the name implies, they should balance, i.e. the total of your assets should equal the total of your liabilities and equity.

Assets = Liabilities + Equity

Your current assets are made up of the following:

• Accounts payable: These are the amounts your company owes to suppliers for goods or services you've bought on credit. You'll often need to make payment in 30 to 60 days.

• Short-term debt: This includes short-term bank loans or lines of credit that need to be repaid within the year. It may also include the current portion of your long-term debt, i.e. the part of that debt you need to pay back within the year (unless your accountant chooses to treat that as a separate line item in this part of your balance sheet).

• Accrued liabilities: These are expenses that have been incurred but not yet been paid. In other words, you've received something of value but not yet paid for it. Usually, they include staff wages, rent and utilities (if you're lucky enough to pay in arrears) or taxes on your profits.

• Deferred revenue: This is money you've received upfront for the supply of goods or services you've not yet delivered. You'll record it as a liability until you fulfil your obligation.

• Other current liabilities: This reflects money you owe for items that don't fit into the other categories. For example, customer deposits, VAT payable or other sundry items.

It's important you understand your current liabilities so you can manage your cash and meet your short-term payments without financial strain.

Let's break that down:

• Liquidity management: As we discussed in our current assets newsletter, if your balance sheet is very liquid, it means you should easily be able to pay what you owe as amounts fall due. Managing your current liabilities well is critical to this.

• Free money: As you can no doubt see, your current liabilities can be a source of 'free money' — through time lags in paying what you owe and getting early payments from your customers. Where the former is concerned, we'd advise that you manage this respectfully — your suppliers need to pay their bills too. But negotiating favourable credit terms can help minimise your need for external financing with associated borrowing costs.

• Working capital efficiency: We'll explain working capital ratios in more detail in a future newsletter (of which current liabilities form a part). However, it's worth noting here that receiving money that's owed to you quickly and delaying paying what you owe until it's due can clearly work in your favour.

To sum it all up, understanding your current liabilities will help you manage the financial health of your company — by minimising liquidity risks, ensuring your creditworthiness and thus boosting stakeholder confidence.