Current liabilities: The balance sheet’s nagging component

Managing financial obligations in the short term is essential for business survival.

All businesses are financed by a combination of equity and debt. Few are all self-funded through their equity, and most rely on outside funding (debt) for the purchase of assets.

Outside funding is either a long-term debt that is due in over one year, or a short-term debt that is due in less than one year. Short-term debt is often called current debt or current liabilities. Current debt is rightly named since your ability to make your desired sales to pay back this debt is dependent on how you can navigate the river of commerce.

Current debt involves four different parts:

  1. Operating accounts payables
  2. Trade accounts payables for goods
  3. Current maturities on long-term debt
  4. Short-term notes

Careful management of current liabilities in real time is the daily fiduciary responsibility for navigating the business ship of state successfully.

Operating accounts payable includes the debt owed within the month for utilities, insurance, rents, taxes, vehicle and payroll expenses that are constantly reoccurring and need to be kept up to date. Since many of these expenses are owed to individuals or businesses within their community, a businesses ability to pay these bills affects their reputation. A good reputation is hard to obtain and even harder to repair.

Trade accounts payables for goods, however, involves debt that usually has terms for payment at a later date ranging from 10-30 days and perhaps a discount for early payment. Inventory is usually an example of this since it can be financed by both equity and trade payables. An excellent inventory tracking system can minimize new purchases, thus keeping debt under control and in line with sales. To ensure that you aren’t ordering more inventory than what you can pay for, you can calculate your turnover rate. Turnover rate is found by dividing the total of what you own for your inventory by the monthly accounts payable total. A ratio of more than 12 times indicates payables are turning in less than 30 days. Likewise, a ratio of less than 12 times could indicate a red flag problem in staying current with vendors. One additional tool is the hands-on approach of manually aging payable invoices. Further auditing by contacting suppliers to verify amounts and due dates could be eye opening.

Providers of long-term debt generally require an orderly pay down of debt over time. Amounts loaned for depreciable assets need to keep pace with value. The total of payments due in the operating year is referred to as current maturities on long-term debt. These payments should be in line with the combination of earnings and depreciation, the first from the bottom line, the other from the (non-cash) expense line. Failure to generate sufficient funds for long-term debt retirement can only be remedied by sale of fixed assets (sometimes not voluntary), infusion of owner’s (or other’s) cash or reduction of working capital. All represent undesirable options.

Needing to borrow “Two ‘till Tuesday” is a request bankers hear frequently. Short term financing for seasonal inventory or to cover your debt until your expected sales (receivables) come in is usually a 6 to 12 month loan. Failure to meet expectations results in conflict and disappointing a lender should, whenever possible, be avoided.

A well prepared and realistic cash flow statement should be prepared every year to ensure that you can manage your debt. A three year rolling cash flow budget can also be very useful and a yardstick for management. Keeping current with your debt (liabilities) not only provides a good image, but is a vital tool for growth. Useful tools for cash flow development are offered by the Small Business Association.

Michigan State University Extension, in partnership with the MSU Product Center provides business guidance for new and emerging Michigan Businesses.

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