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Liabilities are what the company owes. Current liabilities are due within one year and include accounts payable (amounts you owe for day-to-day operations), credit card balances, and the payments you’re required to make on long-term debt in the next year, if applicable.
Long-term liabilities are due after one year, like a mortgage on a building, for example.
These are day-to-day payables that are required for the regular business your company conducts (although slightly different, accounts payable and trade payables are usually used interchangeably). Think of this is as the opposite of accounts receivable. The amount your business owes to another company is a receivable for them. Likewise, the amount receivable to your company from another business is a payable for them.
By calculating the average time your payables are outstanding you can tell how long it takes for you to pay suppliers. How long you leave payables outstanding is cash management decision. The longer you leave it, the longer you hold on to your cash to use for other things. Say your supplier offers 2/10 net 30 terms (recall from lesson 2 that means a 2% discount if paid within 10 days, entire balance due in 30 days). Can you make more than 2% on your cash in 30 days? If so, it’s probably worth it to wait until day 30 to pay the bill because you’ll make more than the 2% you would’ve saved. If not, you could pay the balance in 10 days and save yourself 2%. Comparing options for payment timing is a basic concept of cash management.
Letting it go past the due date isn’t recommended. Even if the amount of interest you would pay is lower than what you could make on your free cash, your supplier won’t want to deal with you if you’re consistently paying them late.
This is the amount a company is required to pay on any long-term debt within the year. Mortgage payments or car payments due within the year fall into this category. As the long-term debt becomes due, it’s moved from long-term liabilities into current liabilities and eventually moved off of the balance sheet by being paid-out.
Debt is usually compared to assets (lesson 2) and equity (lesson 4) to show the relationship between what’s owned and what’s owed. If a company owes a lot more than it owns, that’s a problem.
Comparing current liabilities to current assets (current assets/current liabilities) gives you a ratio that describes how easily the company can cover short term debts with liquid assets. We talked about this a little bit in lesson 2. For example, if current liabilities are twice as much as current assets, the company will have difficultly being able to pay suppliers and make mortgage payments. If, on the other hand, current assets are twice as much as current liabilities, the company should have no problem paying bills and might be in a good position to invest in some new equipment.
While none of us really like to owe money, sometimes it’s useful. As long as the money you borrow is making more than it costs to borrow, you’ll come out ahead. By not borrowing you may be missing an opportunity as well. It will take a lot longer to build and grow a business if you only use your own money. Borrowing allows you to invest a large sum of money into your company to pay for things like new equipment with more capacity, or a faster production speed. An investment like that would allow you to grow the business, pay off the loan and ultimately improve your position. Debt financing versus equity financing also allows you to retain control over the company because you haven’t sold a piece of the company to someone else, who you are now responsible to. We’ll talk more about equity in lesson 4.
If you’re interested in learning about financing options or you’d like to learn how to pay down your debts, I’d be happy to talk to you about it.
Kaitlin Kirk is a Chartered Professional Accountant who helps small business owners learn about their financial situation, work less, and get paid more. She used to do financial process improvement for a $5 billion company and now brings those big business skills and insights to small business owners. She spends a lot of time on the volleyball court and on-stage doing improv comedy when she’s not teaching small business owners how to decode their financial statements.