Role of current liabilities and liquidity in accounting Essay
Role of current liabilities and liquidity in accounting
A liability refers to the present obligation to an organisation following a past transaction and which is expected to be paid from cash or other near cash forms. It is simply put as that which the company owes others. Current liabilities are one of the types of liabilities in an organisation the other being longterm liabilities. Current liabilities refers to those liabilities that are payable within a duration of one year or less. Longterm liabilities can be paid in more than one year.
Current liabilities include payables such as salaries, creditors arising from short-term obligations for example purchases of supplies,taxes payable, overdrafts and short-term loans. Liquidity on the other hand refers to the ability of an asset to be converted to cash quickly. The easier the ability, the more liquid the asset is. Cash is considered to be the most liquid asset since it is already in cash form. Liquidity is also used to refer to the ability of debtors to pay their debts when they fall due.
Liquidity management therefore means that an organisation should be able to maintain sufficient cash and liquid asstes to pay their expenses. The ability to pay is measured using liquidity ratio. Analysts and creditors use the current ratio which divides current by liabilities or quick ratio which divides current assets minus inventions by current liabilities. The higher the ratio the higher the liquidity and hence the ability to pay obligations when they arise. Liquidity of liabilities is measured according to their due dates.
Longterm liabilities are payable in more than one year and therefore do not require fast cash. However, short-term liabilities(current liabilities) require that the organisation maintains ready cash to pay for them when they arise. Role of current liabilities and liquidity Current liabilities and liquidity show the financial position of the business. When a company has many debts, it is not viewed as being in a good financial position. This is because it is expected to draw alot of cash from its account to pay expenses.
The lesser the debts that a company has the better its financial position. A slightly high liquidity ratio shows that the organisation is doing well financially. This is according to Diamond,Slice, E. K & Slice,J. D. (2000). Similarly, when liquidity is low to a certain extent the business is seen as not being in a position to repay its debts or in financial crisis. In obtaining financing from banks and obtaining goods from creditors, current assets and liquidity play a significant role. Liquidity measures help in ascertaining ability of a firm to repay its loans and debts.
Low liquidity measure would indicate poor management or financial problems. Liquidity measure is one of the factors that creditors and bankers consider before lending to a company. A company with a high liquidity ratio is likely to obtain a loan easily because it shows its ability to repay. Attracting potential investors and business partners will require an impressive balance sheet (William et al, 2008). No investor will want to cash in his money in a business with poor financial position. Investors and business partners want to identify the best business with the best return for their money.
Liquidity and current liability of the business will give them the details that they need. References Diamond, M. A. ,Slice, E. K. , and Slice,J. D. (2000). Financial Accounting: Reporting and Analysis harriman: House limited. Williams, J. R. , Susan F. H. , Bettner, M. S. , Carcello, J. V (2008). Financial & Managerial Accounting. Irwin: McGraw-Hill . es. oxfordjournals. org/cgi/content/full/khn009v1 – Similar pages – by J Fingard – (2008) www. journals. cambridge. org/abstract_S000711450809466X , (2008).