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Current Liabilities are company debts due within one year or one operating cycle, whichever is greater. An operating cycle is the time it takes a company to purchase inventory and convert it into cash from sales. 

Current Liabilities include items such as accounts payable, short-term debt and taxes payable. They are handled separately from Long Term Liabilities, which include long-term borrowing, bonds payable and long-term lease obligations, which are due in longer than one operating cycle or one year.

Current Liabilities are usually derived from operating activities and are expected to be paid with Current Assets. Examples of current assets that are used to pay current liabilities include accounts receivable, inventory, liquid assets and cash. 

Having an optimal amount of Current Assets to pay Current Liabilities is necessary for good cash management. Analysts usually measure this with two metrics. 

1. The Current Ratio. This is the result of Current Assets divided by Current Liabilities. A result greater than one means there are enough Current Assets to pay Current Liabilities. A result less than one is a red flag for analysts as it means there are not enough current assets to pay current liabilities.

                  Current Ratio = Current Assets / Current Liabilities

2. Working Capital. This is the result of current assets minus current liabilities. It shows investors and analysts the excess of current assets over current liabilities of a company. While it is always good to have more current assets than current liabilities, too much working capital could be a sign that management is not handling current assets effectively.

                  Working Capital = Current Assets - Current Liabilities

If SmartReaders Inc. has $5 million in cash, $10 million in books as inventory, $6 million accounts payable and $4 million in short term debt, its Current Ratio is 1.5 and its working capital is $5 million. 

SmartReaders Inc Current Ratio=

($5 million cash + $10 books inventory) / ($6 million accounts payable + $4 million short term debt) = 1.5

SmartReaders Inc Working Capital = 

($5 million cash + $10 books inventory) – ($6 million accounts payable + $4 million short term debt) = $5 million

 

 

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