Liabilities and Capital
The liabilities and capital (shareholders’ equity) section of the balance
sheet shows the claims of owners and creditors against the asset values of
the business. It presents the various sources from which the firm obtained
the funds to purchase its assets and thereby conduct its business. The liabil-
ities represent the claims of people who have lent money or extended credit
to the firm. We use the terms capital, net worth, and equity accounts inter-
changeably. These terms represent the investment of the owners in the
business.
This, the credit side of the balance sheet, is often called the financial
section of the balance sheet or the financial structure of the firm. It is espe-
cially important to the student of finance. Many of the items found here
are discussed only briefly in this chapter since they are taken up in consid-
erably more detail in other parts of the book.
Current Liabilities
The current liabilities are those liabilities, claims, or debts that fall due
within one year. Among the more common current liabilities are accounts
payable, representing creditors’ claims for goods or services normally sold
on open account, and notes payable or trade acceptances payable arising
out of similar economic transactions.
Notes payable to bank, bank loans payable, or similar accounts show
the amounts owing to banks for money borrowed. Usually these arise from
short-term loans, but the amounts due within the year on installment or
term loans are also current liabilities. Similarly, any portion of the long-
term debt (i.e., bonds, mortgages, etc.) maturing during the year is also
carried in the current liabilities section. Accruals, a common group of cur-
rent liabilities, represent claims that have built up but are not yet due, such
as accrued wages, interest payable, and accrued taxes. An item that ac-
counts for the bulk of many corporations’ accruals today is the amount
owing on the federal and state corporation taxes. It appears as accrued in-
come tax, provision for federal income tax, or other similar title. Dividends
on the common or preferred stock that have been declared but have not yet
been paid are carried among the current liabilities as dividends payable.
The relationship of current liabilities to current assets is useful in many
types of financial analysis and is especially important in analyzing the
short-run credit position of the firm. Thus, the current liabilities are di-
vided into the current assets to obtain the current ratio, and the current lia-
bilities are subtracted from current assets to obtain the firm’s net working
capital. The larger the current ratio and the larger the net working capital