The balance sheet of a business shows current assets and liabilities. Liabilities reported on the balance sheet are generally debt obligations. Often comprised of both short-term and long-term liabilities, examples might include common transactions such as accounts payable under short-term and corporate bonds under long-term. Paying off an account payable immediately affects the liabilities of the company.
Understanding Current Liabilities
Typically, current liabilities include obligations due within the coming year or within the base operating cycle of the business. A company may refer to current obligations as “spontaneous liabilities” or as “trade credit” when referring to accounts payable. In this scenario, a supplier grants the company short-term trade credit, normally for up to 120 days, allowing the business to purchase items for its operation. This extension of business-to-business trade credit through accounts payable is the largest source of short-term financing, according to a presentation by Illinois State University.
An operating or working capital cycle is the time from purchasing a product to selling it and receiving payment. The operating cycle varies, depending on the type of business. For example, a retailer purchases products for resale. The retailer's operating cycle may start when the initial inventory is purchased and end when the retailer's customer pays for the product. With a manufacturing business, the operating cycle could be an extended period, depending on the time line for converting raw materials to a finished product. Current liabilities then are obligations due within this time of the operating cycle. Accounts payable generally fall into the category of current liabilities.
Accounts Payable Example
A common example of an accounts payable transaction is an order for supplies. Consider a manufacturing company that produces widgets comprised of 12 parts; and suppose the manufacturer orders each of the 12 parts from a different supplier. In this example, just for supplies, the manufacturer may have 12 files for accounts payable. The total amount owed to the suppliers would be a short-term liability because the suppliers expect timely payment. If the manufacturer pays the 12 invoices, the liabilities of the manufacturer are reduced by the amount paid to clear the accounts.
Reducing Accounts Payable
Both long-term and short-term debts increase a company’s liabilities. Increasing accounts payable increases liabilities. Decreasing accounts payable decreases liabilities and cash assets are reduced by an equal amount. Thus, if the business clears any account payable item, current liabilities are reduced, not increased.
- Austin Community College: Preparing Journal Entries
- College of San Mateo: Chapter 12 – Statement of Cash Flows
- Illinois State University: Current Liabilities Management
- Jacksonville State University College of Commerce and Business: Statement of Cash Flows
- Principles of Accounting: Chapter 12
- U.S. Small Business Administration: Understanding and Controlling Cash Flow