Financial Statement Series: Balance Sheet, Part 2, Current Liabilities
- Rylan Kaliel
- Feb 13
- 5 min read
Updated: Apr 11
In the last blog, we did a quick overview of the current assets and what to look for when assessing their quality and viability. In the Balance Sheet, the next segment that would be represented would be the long-term assets. However, considering current assets are typically utilized to pay for the current liabilities, in this humble author’s opinion, it is best to speak about those next and leave the long-term assets to deal with the long-term liabilities.
Understanding Current Liabilities on the Balance Sheet
The current liabilities share some similarities with current assets: they are current and are liquid. However, the stark difference between them is that the current assets represent the near-future inflow of cash, and the current liabilities represent the near-future outflow of cash. The following are the most common ones you will see, but keep in mind that any liability that must be paid within a year is designated as a current liability.
Accounts Payable
This account encompasses all the cash that is owed by you to your vendors. Smaller businesses will typically include their utilities and rent under the same umbrella as well. As a side note, as you grow and the amounts for utilities and rent become more significant, you might want to separate them into other accounts to gain more insight when looking at your Balance Sheet.
It is prudent as a business to build a good relationship with your vendors. The better they like you, the better terms they are willing to give you. When you are starting out, you may be given terms such as prepayment for goods, cash upon receipt, or, best-case scenario, 30 days. If you take the time to build good relationships by adhering to the terms and conditions of your contract with them as well as interacting with them (always good to find one person that you deal with consistently from that company), you will be able to get more favorable terms such as 45 days or 60 days to pay. Think of it this way: if you like a customer, you’d be inclined to let them pay later, wouldn’t you?
It is prudent to look at your accounts payable at least on a weekly basis and plan for the payments that are coming due in the next few weeks. You don’t want to put yourself in a position where you push everything to the end of the period and then have to make big lump-sum payments that leave your cash accounts deflated and expose you to having to use credit or, worst-case scenario, bouncing payments.
Other Current Liabilities
While accounts payable is the most significant current liability, there are a few other worth noting. We've put together a brief list of these and there descriptions to help you understand, without being too overwhelming for these lesser thought of accounts.
Taxes Payable: These are taxes you have to pay to the government within a year, including income taxes and GST payables. If you have quarterly reporting, it may be beneficial to separate GST from other taxes.
Bonus Payable: This account tracks bonuses to employees or yourself within a one-year period.
Notes Payable: Any loans payable within a year of their inception.
Key Ratios for Current Liabilities
Like current assets, there are ratios to help you analyze your current liabilities. There are three main ratios that are used to aid you in assessing how robust your accounts payable are:
Accounts Payable (AP) Turnover Ratio
The accounts payable turnover ratio, or AP turnover, intends to show you how long it takes you to pay your accounts payable. This is very similar to the AR turnover ratio that we discussed in our previous post. Let's work through an example to see this in action.
Formula: Total Credit Purchases for the Period / Average Accounts Payable for the Period
Example Calculation:
Credit purchases: $100,000
Beginning balance: $5,000
Ending balance: $30,000
Average AP: (30,000 + 5,000) / 2 = $17,500
AP Turnover: 100,000 / 17,500 = 5.71
This means that, in that period, you paid your accounts payable 5.71 times. However, this is not the easiest way of explaining what happened, which brings us to the next ratio.
Accounts Payable (AP) Turnover in Days
Similar to the days in receivable ratio we discussed in our previous post, this tells us how many days it took for you to pay your accounts payable. We already noted, no one is shouting from the rooftops that they have a 5.71 AP turnover, so let's make this a little more clear.
Formula: Number of Days in the Period / AP Turnover
Example: 365 / 5.71 = 64 days
This means that every 64 days you pay off the balance of your accounts payable. When looking at this number, keep in mind your contract terms. If you are supposed to pay vendors every 30 days but in reality, you are paying them every 64 days, you could be damaging vital relationships and missing out on discounts.
Current Ratio
The last ratio that will look at is the current ratio. This ratio shows you the relationship between current assets and current liabilities. For most smaller companies the current liabilities are mainly made up of accounts payable. Therefore, we are only discussing that account in depth. However, there are other current liabilities account that could exist which will be briefly discussing after this, if your company has any of these then you will want to add them to this ratio as well.
Formula: Current Assets / Current Liabilities
Example Calculation:
Current assets:
Cash: $10,000
Accounts Receivable: $50,000
Inventory: $20,000
Current liabilities:
Accounts Payable: $30,000
Taxes Payable: $20,000
Notes Payable: $10,000
Current Ratio: (10,000 + 50,000 + 20,000) / (30,000 + 20,000 + 10,000) = 1.33
This means that with the current assets you have, you can pay your current liabilities 1.3 times. This ratio is crucial for the short-term prosperity of the company, ensuring that you have money to pay your current liabilities. Lenders also pay attention to these ratios when making lending decisions, as everyone wants to ensure they are paid for their investments.
Conclusion: Consider Your Current Liabilities
Understanding your Balance Sheet, current liabilities, and key financial ratios helps you make informed decisions for business growth. Regularly evaluating your accounts payable and other short-term liabilities ensures your company can pay your bills on time and continue to prosper.
Stay tuned for the next in our Financial Statement Series where we will discuss long-term assets, the most significant investment in your business.
Need professional accounting guidance? KLV Accounting is here to help. Contact us today to enhance your financial strategy and drive business success!
For a free consultation, call us at 403-679-3772 or email us at info@klvaccounting.ca.
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