What Are Examples of Short Term Liabilities?

A business’s financial obligations are known as liabilities. A liability is classified as short-term, or current, if it is expected to be settled within one year or the business’s normal operating cycle, whichever is longer. Since the operating cycle for most businesses is less than a year, the one-year mark is the standard for classifying these obligations.

Common Examples of Short Term Liabilities

Accounts Payable

Accounts payable represents the money a business owes to its suppliers for goods or services received on credit. For instance, when a restaurant receives a shipment of produce from a vendor, the vendor issues an invoice with payment terms, such as “net 30,” meaning the payment is due within 30 days. The amount owed is recorded as accounts payable on the restaurant’s books until the invoice is paid.

Short-Term Notes Payable

Short-term notes payable are formal written promises to repay a specific amount of money, usually with interest, within one year. A business might issue a short-term note to a bank to secure financing for a temporary cash shortfall. For example, a retail store might take out a $20,000, 90-day note from a bank to purchase extra inventory, obligating the store to repay the principal plus accrued interest by the note’s maturity date.

Accrued Expenses

Accrued expenses are costs that a business has incurred but has not yet paid. These are recognized in the accounting period in which they are incurred. Common examples include salaries and wages owed to employees for work they have already performed but for which they have not yet received a paycheck. Another frequent accrual is for interest on debt.

A significant category of accrued expenses relates to taxes. Businesses are responsible for various taxes that are incurred in one period but paid in a future one. This includes payroll taxes, such as the employer’s share of Social Security and Medicare. Companies also accrue for income taxes payable, estimating their tax obligation throughout the year before payment is made.

Unearned Revenue

Unearned revenue is a liability created when a company receives payment for goods or services it has not yet delivered. The company must either provide the goods or services or return the money. For example, if a software company receives a $1,200 annual subscription fee upfront, it records the full amount as unearned revenue. Each month, as the service is provided, the company recognizes $100 as earned revenue and reduces the unearned revenue liability.

Short-Term Portion of Long-Term Debt

Many businesses take on long-term debt, such as a mortgage or a multi-year bank loan, to finance major purchases. While the total loan is a long-term liability, any portion of the principal that is due within the next 12 months is reclassified as a short-term liability. This reclassification provides a more accurate picture of the company’s immediate cash needs.

Dividends Payable

A dividends payable liability is created when a corporation’s board of directors declares a dividend for its shareholders but has not yet paid it. The declaration creates a legal obligation to pay. For example, if a board declares a cash dividend of $1 per share on 50,000 outstanding shares, a $50,000 liability is recorded as dividends payable until the payment is distributed to shareholders.

Presentation on the Balance Sheet

Short-term liabilities are presented on a company’s balance sheet under the heading “Current Liabilities.” This section aggregates all obligations due within one year, providing a single figure that summarizes immediate financial commitments. The specific accounts are often listed in the order they are expected to be paid, such as accounts payable, accrued expenses, and short-term notes payable.

For example, a simplified current liabilities section on a balance sheet might look like this:

Current Liabilities:
Accounts Payable: $75,000
Accrued Salaries: $25,000
Unearned Revenue: $15,000
Short-Term Notes Payable: $50,000
Current Portion of Long-Term Debt: $40,000
Total Current Liabilities: $205,000

Importance in Financial Analysis

The analysis of short-term liabilities is important for evaluating a company’s liquidity, its ability to meet immediate financial obligations. A high level of current liabilities relative to current assets can indicate potential cash flow problems, so investors and lenders monitor this section to gauge financial stability.

Financial analysts use several metrics to facilitate this analysis. One is working capital, calculated by subtracting total current liabilities from total current assets. A positive working capital figure indicates the company has sufficient short-term assets to cover its short-term debts.

Another metric is the current ratio, calculated by dividing total current assets by total current liabilities. A current ratio of 2:1, for example, means the company has two dollars of current assets for every one dollar of current liabilities. This ratio provides a standardized measure of liquidity for comparison against industry peers.