Short-Term Liabilities
Short-term liabilities, often referred to as current liabilities, are obligations or debts that a company needs to settle within one year or within its normal operating cycle, whichever is longer. They represent amounts owed to creditors, suppliers, employees, and other entities in the near term.
Here are some common examples of short-term liabilities:
- Accounts Payable (AP): These are amounts owed to suppliers for goods or services received on credit. It’s a common business practice to purchase items on credit, which creates an obligation to pay the supplier at a later date, typically within 30, 60, or 90 days.
- Short-Term Loans: Any loan or line of credit that needs to be repaid within one year falls under this category.
- Current Portion of Long-Term Debt (CPLTD): If a company has long-term debt, such as a multi-year loan, the portion of that debt that is due within the next 12 months is classified as a short-term liability.
- Accrued Liabilities: These are expenses that a company has incurred but hasn’t yet paid. Examples might include wages owed to employees but not yet disbursed, or interest that has accumulated on a loan but hasn’t been paid off.
- Unearned Revenue: When a company receives payment in advance for goods or services that it will deliver in the future, it records this as unearned revenue. It represents a liability because the company owes the customer the product or service. As the goods or services are delivered, the unearned revenue is recognized as revenue.
- Other Current Liabilities: This can include items such as taxes payable, dividends declared but not yet paid, and any other obligations due within a year.
It’s important for companies to effectively manage their short-term liabilities to ensure they have sufficient liquidity to meet these obligations as they come due. One common measure of a company’s ability to do so is the current ratio, which is calculated by dividing current assets by current liabilities.
Example of Short-Term Liabilities
Let’s create a hypothetical scenario involving a small business called “Sunny Day Apparel” to illustrate the concept of short-term liabilities:
Sunny Day Apparel specializes in summer clothing. The company has been operational for a few years and has a mix of current assets (like cash, accounts receivable, and inventory) and current liabilities.
At the end of June 2023, their balance sheet showcases the following short-term liabilities:
- Accounts Payable: Sunny Day Apparel owes its suppliers $10,000 for the raw materials and finished products it purchased on credit.
- Short-Term Loan: The company took out a $5,000 loan for a quick marketing campaign, which needs to be repaid by the end of August.
- Current Portion of Long-Term Debt: The company has a $50,000 loan that’s being paid over 5 years. The installment due within the next year is $10,000.
- Accrued Liabilities: At the end of June, Sunny Day Apparel owes $2,000 in wages to its employees for work done in the last week of the month.
- Unearned Revenue: The company introduced a special offer where customers could pre-order a new line of t-shirts. They received $3,000 in advance payments, but these t-shirts are yet to be shipped.
- Taxes Payable: Based on their sales, they owe $1,500 in sales taxes that they collected from customers but have not yet remitted to the state.
Total Short-Term Liabilities: $10,000 (AP) + $5,000 (Short-term Loan) + $10,000 (CPLTD) + $2,000 (Accrued Liabilities) + $3,000 (Unearned Revenue) + $1,500 (Taxes Payable) = $31,500
For Sunny Day Apparel to maintain a healthy financial position, they need to ensure that they have enough current assets, such as cash or assets that can be quickly converted to cash (like accounts receivable and some inventory), to cover these liabilities when they come due.
If they find that their current assets fall short, they might need to reconsider their operations, negotiate terms with creditors, or seek additional financing to bridge the gap. On the other hand, if their current assets significantly exceed their short-term liabilities, they might have opportunities to invest back into the business, seek advantageous terms with suppliers, or explore growth opportunities.
