Driving Your Company's Value

Understanding Your Financial Statements – Part 10: Current Liabilities

Current liabilities represent the debts of the company which will have to be paid within the next twelve months.  This is similar to current assets in that it represents items that will affect the company’s cash flow in the next 12 months.

Current liabilities commonly include:  accounts payable, salaries payable, accrued expenses, income and payroll taxes payable, and the current portion of notes and mortgages payable.

Financial statement analysis questions that should be asked related to the company’s current liabilities include:

1. Are your current liabilities less than your current assets?  Is this a change from the prior period or previous year?  What are the factors that caused the change?
2. Current liabilities represent what percentage of total assets (current liabilities divided by total assets)?  How does it compare to the prior period or prior year?  How does this compare to industry comparative data?
3. Should you consider a long-term bank loan or additional capital (money) investment in your company to lower your current obligations? 
4. Do you have a good relationship with your banker and other creditors? How will any changes in current liabilities affect that relationship?
5. Do you pay down your line-of-credit to zero at least once a year?  If not, should you consider a long-term bank loan or additional capital (money) investment in your company? 
6. Do you have payroll taxes payable?  If so, are you facing penalties for late payment?
7. Are you depending on short-term loans to support your company?

The Profit Equation

In 1971, the Boston Consulting Group promoted their very handy analysis tool for understanding a company's profit and its drivers.  They named this tool “The Profit Equation”.

The equation lists the key drivers of revenue growth and profitability. Once you have identified and quantified these items you can analyze them and focus in on improvements where they will add the most value. In addition, you can do very simple but valuable simulations to determine which items will have the greatest effect on profitability.

The equation is presented in a vertical format as follows:

                Existing # of Customers at Beginning of Period
                Plus: Customers Gained
                Less: Customers Lost
                Equals: Total Customers at End of the Period

                Times: Transactions per Customer
                Times: Average Sale Amount Per Transaction
                Equals: Total Revenue

                Less:  Cost of Sales

                Equals: Gross Profit
                Less  Selling and Administrative Expenses

                Equals: Net Operating Income

Take the time to calculate your company's profit equation. Build a simple model on an Excel spreadsheet and give it a try.  You will be surprised at the value of these simple management decision making tools, when you start to use them.