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Current Liabilities

Investing Lesson 3 - Analyzing a Balance Sheet


Debt consolidation form being signed
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Current liabilities found on the balance sheet are the debts a company owes which must be paid within one year. They are the opposite of current assets. Current liabilities includes things such as short term loans, accounts payable, dividends and interest payable, bonds payable, consumer deposits, and reserves for Federal taxes.

Let's take a look at some of the most common and important current liabilities on the balance sheet.


Accounts Payable - The Most Popular Current Liability

Accounts payable is the opposite of accounts receivable. It arises when a company receives a product or service before it pays for it. Accounts payable, or A/P as it is often shorthanded, is one of the largest current liabilities a company will face because they are constantly ordering new products or paying vendors for services or merchandise. Really well managed companies attempt to keep accounts payable high enough to cover all existing inventory, meaning that the vendors are paying for the company's shelves to remain stocked, in effect. The most effective operators in industries such as discount retailers, Target and Wal-Mart among them, have turned this into an art. In a very real sense, their business growth was funded by vendors such as Procter & Gamble and Clorox, both of which shipped products to the store shelves on credit, giving the merchants a chance to sell the goods before paying the amount owed to these wholesalers. This meant both Wal-Mart and Target could use more of the money they had raised from shareholders, bondholders, and retained profits to fund new store expansion.


Accrued Benefits and Payroll as a Current Liability

This item in the current liabilities section of the balance sheet represents money owed to employees as salary and bonus that the company has not yet paid.


Short Term and Current Long Term Debt

These current liabilities are sometimes referred to as notes payable. They are the most important item under current liabilities section of the balance sheet and most of the time, they represent the payments on a company's bank loans that are due in the next twelve months. Borrowing money in itself is not necessarily a sign of financial weakness; an intelligent department store executive may work out short term loans at Christmas so she can stock up on merchandise before the Holiday rush. If demand is high, the store would sell all of its inventory, pay back the short term loans, and pocket the difference. This is known as utilizing leverage. The department store used borrowed money to make a profit.

So how can you ever hope to tell if a company is wisely borrowing money (such as our department store), or recklessly going into debt? Look at the amount of notes payable on the balance sheet (if they aren't classified under 'notes payable', combine the company's short term obligations and long term current debt). If the amount of cash and cash equivalents is much larger than the notes payable, you shouldn't have any reason to be concerned.

If, on the other hand, the notes payable has a higher value than the cash, short term investments, and accounts receivable combined, you should be seriously concerned. Unless the company operates in a business where inventory can quickly be turned into cash, this is a serious sign of financial weakness.


Other Current Liabilities

Depending on the company, you will see various other current liabilities listed. Sometimes they will be lumped together under the title "other current liabilities." Normally, you can find a detailed listing of what these "other" liabilities are buried somewhere in the annual report or 10K. Often, you can figure out the meaning of the entry by its name. If a business lists "Commercial Paper" or "Bonds Payable" as a current liability, you can be fairly confident the amount listed is what will be paid out to the company's bond holders in the short term.


Consumer Deposits Are Liabilities to Banks

If you are looking at the balance sheet of a bank, you will want to pay close attention to an entry under the current liabilities called "Consumer Deposits". Often, they will be will lumped under other current liabilities. This is the amount that customers have deposited in the bank. Since, theoretically, all of the account holders could withdrawal all of their funds at the same time, the bank must list the deposits as a current liability.

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This page is part of Investing Lesson 3 - Understanding the Balance Sheet. To go back to the beginning, see the Table of Contents. If you have already read this lesson, you can skip directly to the Balance Sheet Quiz.

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