A company has to have enough money to cover its short-term expenses if it wants to be successful, and in order to plan for those expenses, it needs to know what they are. The concept of current liabilities encompasses the most common immediate cash needs that a business has, and it includes short-term debts that are due in less than one year. There are several different categories of current liabilities, but what they all have in common is that the company has to make sure it has cash on hand to pay them off as they come due.
The categories of current liabilities
Most companies have different types of current liabilities, but you'll commonly see several categories repeatedly as you analyze different companies. Accounts payable are bills that a business owes to suppliers, employees, and other providers of raw materials or services necessary for the business. When a company sends you a bill, it becomes an account payable until you pay it.
Similarly, accrued expenses are costs that a business incurs but hasn't yet paid. For example, if you make yearly subscription payments for a certain service at the end of the term, then most businesses will accrue a portion of those expenses every month to match up with their use of the service involved. One type of accrued expense is income tax liability, which often gets its own separate category because of its universal importance.
Finally, debt payments are broken into short-term notes payable and the current portion of long-term debt. Short-term notes payable include lines of credit and other debt obligations that mature within 12 months. Long-term debt is only current to the extent that interest and principal payments are due within that one-year timeframe.
Should you worry about current liabilities?
Every business incurs costs, so you'll always see current liabilities on a corporate balance sheet. The question is whether the business has enough current assets to cover the financial obligations it has as they come due. The most financially secure companies have enough cash on hand to cover current liabilities, but that isn't strictly necessary. As long as a company can generate enough cash from its other assets, such as inventory for sale or accounts receivable on which it needs to collect, then having low levels of current cash compared to current liabilities won't be problematic.
It's smart to compare current liability levels across companies in the same industry. Different sectors have different conventions with respect to paying off their short-term obligations, and trying to compare companies across different sectors can give you misleading results.
Current liabilities provide useful information to investors about the financial state of a company. If you're comfortable that the company can meet its current liabilities as they come due, then they shouldn't be a source of worry to you as an investor.
This article is part of The Motley Fool's Knowledge Center, which was created based on the collected wisdom of a fantastic community of investors. We'd love to hear your questions, thoughts, and opinions on the Knowledge Center in general or this page in particular. Your input will help us help the world invest, better! Email us at email@example.com. Thanks -- and Fool on!