Updated on 20th November 2024

 

What are current liabilities and how can they impact your business’s ability to manage cash flow?

In this guide, we will help you understand what current liabilities are, which liabilities could be impacting or impeding your company’s success, and how you can use cash management strategies and financial solutions to improve the financial health of your business.

Current Liabilities and Cash Flow Management

Understanding Current Liabilities

A current liability is a short-term financial obligation that a business needs to meet within the current operating cycle.

If it’s not a financial obligation, it’s not a liability. And if it’s not due within the current operating cycle, it’s not considered current.

By operating cycle, we mean the time it takes for you to purchase inventory or stock, sell the goods on to your customers, and then receive payment.

The most significant current liability for SMEs is usually accounts payable. This is the money your business owes to suppliers in the form of unpaid invoices.

Using Current Assets

Most businesses rely on their current assets, such as accounts receivables, to cover the cost of their current liabilities. In other words, the money coming into the business from sales is used to pay for various expenditures and liabilities. What is left over from this revenue is referred to as profit.

The Role of Cash Flow Management

Effective cash flow management or staying across the money flowing in and out of your business, is crucial to ensuring your business can meet its current liabilities, maintain current assets, and turn a profit.

A crucial component of good cash flow management and therefore the financial health of your business is timing. For example, it is important that your accounts receivables are collected from your customers in time to settle your accounts payable from your suppliers.

7 Examples of Current Liabilities

Current liabilities can vary depending on the unique circumstances of your business – not to mention industry, market circumstances and company structure.

For example, some industries can involve much higher current liabilities than others or have customers who are less punctual in settling their accounts.

Let’s break down seven examples of current liabilities.

1. Accounts Payable 

Accounts payable refers to the payments that your company needs to make to suppliers.

Most manufacturers, suppliers and vendors offer net payment terms that allow customers to receive goods and services before paying for them. Usually this is 30 days, but it can vary.

These net payment terms act as a line of credit of sorts in the sense that they enable a customer to make a purchase without the upfront cost. When you purchase inventory on credit terms, the total value of the invoice is listed in your current liabilities.

For businesses without access to sufficient working capital to meet their accounts payable, Invoice Finance can be helpful. But we will get to this financial solution shortly.

2. Accrued Expenses 

Accrued expenses are costs that your business incurs but for which you have yet to receive an invoice.

These current liabilities are used in the accrual accounting method of recording financial transactions, rather than being recorded when your business settles the unpaid invoice.

Some of the most common accrued expenses include debt repayments due in the operating cycle, such as business loans, tax payments, employee wages, or commission payments.

Accrued expenses are short-term financial obligations, so companies with healthy finances and access to working capital can usually cover the cost of these liabilities.

3. Taxes 

Tax – whether income tax payments or other contributions – is recorded as current liabilities if the payment date falls within your business operating cycle. If it doesn’t, it will be a liability but not current.

Your business may also be required to collect and pay Goods and Services Tax (GST) if you sell directly to consumers. Whether or not you are eligible for paying GST will depend on factors such as turnover and other tax arrangements. Those required to do so must report GST and make monthly, quarterly, or yearly payments.

4. Payroll Liabilities 

All payroll costs that are included in your operating cycle are considered to be current liabilities. This includes the cost of the wages themselves but also employee benefits like superannuation contributions, medical insurance, bonuses, and other expenses.

5. ATO Debt  

The Australian Taxation Office (ATO) extends debt to companies that owe income tax, GST, or payroll tax but cannot pay it in full by the due date. ATO debt, like any short-term debt, is a significant current liability for many businesses.

In fact, failure to pay ATO debt on time can lead to further penalties, interest charges, and even legal action. However, by effectively managing current liabilities with strong cash flow solutions, you can both reduce the current financial risk and offload these current liabilities as quickly as possible.

To explore how you can consolidate your ATO debt and reduce financial strain, visit our Consolidate Debt page or speak to our lending specialists.

6. Short-Term Debt 

Current liabilities include the short-term debt your business is due to repay within the current operating cycle.

Some examples of short-term debt include:

  • Bank loan repayments
  • Overdraft facilities
  • Lines of credit

Note that this doesn’t include the total value of long-term loans or other debt commitments. To classify as a current liability, all of the repayments must fall in the operating cycle.

7. Unearned Revenue 

If your business receives payment upfront for goods or services your company has yet to provide, this cash inflow is referred to as unearned revenue.

Unearned revenue is recorded as a current liability. Why? Because it’s a form of debt in that your business owes something to your customer. If the delivery of the goods or services falls in the current operating cycle, it is then registered as a current liability.

How to Work Out Your Current Liabilities Ratio/Quick Ratio

Calculating the current assets to current liabilities ratio is simple. But it is important as it can tell you how well your business is positioned in meeting its debts on time. It’s also a valuable tool for predicting cash flow and managing your financial needs accordingly.

Current Ratio Calculation Example

Most businesses use the current ratio which is calculated by dividing current assets by current liabilities. This will reveal if you have enough assets on your balance sheet to meet your debt repayments and other payables.

For example, let’s say your business has assets of $400,000 and liabilities of $250,000.

Current Assets / Current Liabilities = Current Ratio

$400,000 / $250,000 = 1.6

Quick Ratio Calculation Example

Some small and medium sized enterprises (SMEs) use the quick ratio instead of the current ratio. The formula for the quick ratio is the same, but the difference here is that the total value of inventory is subtracted from the current assets before the calculation.

For example, suppose your company had $400,000 in current assets, but $100,000 was tied up in inventory. You need to deduct the $100,000 from your current assets before calculating the quick ratio – which you did not do in the example above.

Current Assets – Inventory / Current Liabilities = Quick Ratio

$400,000 – $100,000 / $250,000 = 1.2

Why would you use the quick ratio over the current one, or vice versa?

The quick ratio is more conservative than the current ratio as it only includes current assets that you can quickly convert into working capital. It can be helpful to use either ratio depending on what you are trying to understand about your business’s financial health.

What Is a Good Current Liabilities Ratio?

A ratio of 1 indicates you have $1 in current assets for every $1 you owe in current liabilities. A ratio of 5 means you have $5 in current assets for every $1 in liabilities.

In other words, if you have a ratio of less than 1, it indicates that your current liabilities are larger than your current assets. This could reflect the fact that your company could be struggling to meet its financial obligations during the operating cycle.

A number above 1 is generally considered to be a “good” current or quick ratio. But it is important to note that being below one does not always mean that a business isn’t profitable.

Managing Current Liabilities Challenges

As the largest non-bank lender in Australia, ScotPac is best positioned to help your business manage its current liabilities and cash flow challenges.

There are three main solutions that can be used to help meet your current liabilities and debt.

Business Line of Credit

A business line of credit can be a valuable tool for managing current liabilities challenges. It provides a flexible source of accessible funding to cover short-term expenses.

With a business line of credit available, businesses without extensive current assets can still reduce the risk of cash flow shortages. Additionally, a line of credit can help businesses take advantage of discounts for early payment to suppliers or capitalise on other investment and growth opportunities, further improving their financial position.

For a solution that works like a line of credit but offers more flexibility, ScotPac’s Cash Line provides no principal repayments, no need for property security, and approval in as little as 24 hours. Find out more about how Cash Line can support your business’s cash flow needs here.

Business Loan

A Business Loan from ScotPac can also be helpful as a short-term solution for managing short term debt by providing, unlike a line of credit, a fixed amount of funding.

By obtaining a loan, your business can inject some much-needed working capital and free up cash flow. Of course, it’s important to carefully consider the terms and interest rates of a loan to ensure it aligns with the business’s financial goals and capabilities.

For more information, speak to our team about tailoring a business loan for your needs.

Invoice Finance

If your business is experiencing the financial burden of net payment terms, or your accounts payable is due before your company will receive payment for the goods and services already sold, you might need Invoice Finance.

This financial solution allows your business to use outstanding sales invoices as collateral for financing. In other words, you can access tomorrow’s revenue today.

With Invoice Finance, you can access a cash advance of up to 85% of the invoice value within 24 hours of approval. Then, when your customer pays, you get the remaining balance, less any applicable fees.

For more information about what Invoice Finance is, how it works and how it can help you, read our guide here.

ScotPac Business Cash Flow Solutions

Looking for a way to boost your cash flow with Invoice Finance or explore tailored business loan solutions? ScotPac is here to help. With over 35 years of experience, more than 8,500 clients, and $23.9 billion in annual invoice funding, our team is well-equipped to support your business.

Simply fill out our online enquiry form or call us for a chat with one of our lending specialists. We’ll work with you to find the right funding solution for your business.