Question

1. What are the major differences between current and long-term liabilities? Which one is more important, why and why not?

Answer 1

Current liabilities are used by firms to fund their working capital and operational needs. Firms need to maintain a stable cash cycle over the daily or monthly operations to fund their suppliers, manage inventory and receivables to maintain efficiency in operations. If the firm does not employ these short term fund sources, it could result in a liquidity crisis and fund cruch. Typically , current liabilities are more easier and flexible to achieve as creditors have low risk on these funds considering that the amount can be backed by current assets like inventory or receivables. These short term funds also can be flexible in loan terms and repayment in the form of an over draft or cash credit facility.

A firm might prefer long term liabilities, as these funds can be used to fund the growth in the form of investments and also any excess can be used to fund working capital requirements. Thus, long term funds can be used to fund both short term and long term used. Long term funds decide the growth trajectory of the firm and the strategic direction of a firm. Hence long term liabilities are more important if the firm doesnt have enough equity to maintain sustenance. However if the firm has enough equity in its balance sheet, then short term liabilities are more important to maintain a sound liquidity to the firm.