As discussed in the Balance Sheet basics, liabilities refer to the obligations of a business. Current liabilities are the obligations due within one year timeframe. Major items under current liabilities are as follows:
- Payables: This is when a business buys some goods or services on credit. Let’s say our hot dog business owner buys the ingredients from a grocery store with a promise to bill to pay within 30 days. In this case, hot dog owner will record this transaction as a Payable on the company’s balance sheet while the grocery store will record it in Accounts receivables.
- Accrued expenses: These are the expenses incurred by the business but not yet paid out. Typically staff salaries, marketing expenses, which are billed, say monthly/quarterly etc. come under this category.
- Short term debt/loan: This is the loan taken by the company to meet its short term cash requirements, i.e. to buy the inventory for production of goods. As the inventory is sold, the company pays back the loan and repeats the cycle. Other uses of this cash could be payment of bills or anything which is required to keep the business running.
- Long term debt due in 12 months: As the name suggests, the company borrowed money for a tenor greater than 1 year at some point in past, but as of the reporting date the company has to pay it back within 12 months.
For the short term debt, I would also check whether it is used to finance long term assets. If it is doing so, that is red flag as it can potentially pose problems when the liquidity dries up in the market, in other words, when the banks stop lending due to worsening business conditions or other factors. It can also negatively impact the P&L if the interest rates are going up – more the interest rates for rolling over the debt, lesser is the profit left for the business owners.
Other current liabilities, if any, would ideally not be significant enough to worry about.