What it means
A balance sheet separates liabilities by when they must be settled, and a five-year loan does not become due all at once. Each year, the instalments due in the coming twelve months move from the long-term liability to the current liability, so that the reader sees the company's obligations in the order they must be met.
The current portion of long-term debt is that reclassified amount, presented as a separate line or disclosed within current borrowings. The items included are: scheduled principal repayments on amortising loans due within twelve months; the full balance of any loan or bond whose maturity date falls within twelve months, unless refinanced or extended before the balance sheet date under the rules; the principal element of lease liabilities due within twelve months; and long-term debt that has become current because a covenant has been breached and the lender has the right to demand repayment.
Interest accrued is a separate current liability; interest not yet accrued is not a liability at all. The classification rules are strict because the current portion drives liquidity assessment and companies would prefer to show less of it.
Under IFRS (IAS 1), a liability is current if it is due within twelve months and the company does not have, at the reporting date, the right to defer settlement for at least twelve months; a refinancing completed after the balance sheet date does not change the classification at that date (it is disclosed), and a covenant breach at the balance sheet date that gives the lender the right to demand repayment makes the whole loan current unless the lender has agreed before the balance sheet date to waive the breach for at least twelve months. US GAAP (ASC 470) is similar but allows a company to classify debt due within twelve months as non-current if, before the financial statements are issued, it has either refinanced the debt on a long-term basis or entered into a firm financing agreement that clearly permits it to do so; covenant breaches are treated similarly, with a waiver obtained before issuance sufficing in some circumstances.
The difference means that the same balance sheet can show different current liabilities under the two frameworks. The effect on analysis is substantial.
A company with $10,000,000 of current assets and $6,000,000 of current liabilities has a current ratio of 1.67; if $5,000,000 of long-term debt falls due within the year, current liabilities become $11,000,000 and the ratio 0.91. The company has not become less able to pay, but its balance sheet now shows that it must find $5,000,000 in the coming year from cash flow, refinancing or asset sales, and readers, lenders and covenants respond.
A large current portion relative to operating cash flow is a refinancing risk; a current portion that has appeared because of a covenant breach is a distress signal; and a pattern of debt being refinanced at the last moment year after year suggests a company living on its lenders' forbearance. For management, the current portion is a planning item.
The cash flow forecast must provide for it; refinancing must be arranged well before maturity (and, under IFRS, completed before the balance sheet date if the debt is to stay non-current); covenant compliance must be maintained or waivers obtained in time; and the maturity profile of the debt should be managed so that no single year carries more than the company can refinance comfortably.
In practice
Real-world examples.
Example
A property company reclassifies a $50 million mortgage to current liabilities a year before its maturity, and its lenders ask about refinancing plans at the next review.
Example
A retailer's loan becomes wholly current after a covenant breach at year end, and its auditors add a material uncertainty paragraph on going concern until the refinancing completes.
Example
A manufacturer completes a five-year refinancing in November so that at its December year end the maturing debt is non-current under both IFRS and US GAAP.
Think of it
“Current portion of long-term debt is the slice of your long-term loans coming due this year.
Formula
Calculation
Current Portion of Long-Term Debt = Principal repayments scheduled within 12 months + Balances maturing within 12 months (unless refinanced per the rules) + Debt repayable on demand due to covenant breach (unless waived per the rules)
Non-Current Debt = Total debt minus Current portion
Current Ratio = Current assets / Current liabilities (including the current portion)
Refinancing Requirement (12 months) = Current portion minus Expected free cash flow available for repayment minus Committed new facilities
Worked example. A distribution company's borrowings at its 31 December year end:
- Term loan A: $12,000,000 outstanding, repayable in quarterly instalments of $750,000; final maturity in four years. Instalments due in the next twelve months: $3,000,000.
- Term loan B: $8,000,000 bullet repayment due on 30 September next year. No refinancing agreed at the balance sheet date; the bank has indicated willingness to refinance and a term sheet is being negotiated.
- Bonds: $20,000,000 due in six years, interest only.
- Revolving credit facility: $5,000,000 drawn; the facility expires in three years and is repayable at expiry; drawings are rolled monthly at the company's option.
- Lease liabilities: $6,000,000, of which principal due within twelve months is $1,400,000.
- Covenant: term loan A requires interest cover above 3.0, tested annually at year end. Interest cover this year: 2.8. The bank granted a waiver on 15 January (after the year end) for the current test.
Classification at 31 December (IFRS):
- Term loan A: the covenant was breached at the balance sheet date and the waiver was granted after it, so the bank had the right at the balance sheet date to demand repayment. The whole $12,000,000 is current. (Had the waiver been granted on 20 December for a period exceeding twelve months, only the $3,000,000 of scheduled instalments would be current.)
- Term loan B: due within twelve months; no completed refinancing at the balance sheet date: $8,000,000 current.
- Bonds: non-current.
- Revolver: the company has the right to roll drawings under a facility expiring in three years: non-current (some analysts treat revolver drawings as current in substance; the company discloses the facility terms).
- Leases: $1,400,000 current; $4,600,000 non-current.
- Current portion of long-term debt (including leases): $12,000,000 + $8,000,000 + $1,400,000 = $21,400,000. Non-current: $20,000,000 + $5,000,000 + $4,600,000 = $29,600,000.
Under US GAAP, with the waiver obtained before the statements were issued and the bank's term sheet for loan B not yet a firm agreement: term loan A could be classified with only $3,000,000 current (waiver obtained before issuance, breach not expected to recur); term loan B remains current ($8,000,000) because the refinancing is not a firm agreement. Current portion: $12,400,000.
Liquidity effect: current assets $28,000,000; other current liabilities $14,000,000. Current ratio under IFRS: $28,000,000 / $35,400,000 = 0.79. Under US GAAP: $28,000,000 / $26,400,000 = 1.06. Same company, same date, a 27-point difference from the classification rules.
Management's actions, revealed by the analysis: the covenant breach and its post-year-end waiver should have been resolved before the year end (a waiver in December would have kept $9,000,000 non-current under IFRS); loan B's refinancing should have been completed before the balance sheet date; and the company's cash flow forecast must provide for $21,400,000 of repayments in the coming year against expected free cash flow of $6,000,000, meaning $15,000,000 must be refinanced. The finance director's board paper sets out the refinancing plan (a new $10,000,000 term loan to replace loan B, agreed in principle; the revolver drawn for the balance) and a policy that no more than 25% of debt matures in any twelve-month period and that covenant headroom is reviewed quarterly with waivers sought before, not after, any test date.Case study
Seen in the real world.
A listed logistics company had $180,000,000 of bonds maturing in fourteen months at its year end and a further $40,000,000 of term loan instalments due within the year. Its treasurer expected to refinance the bonds in the following spring, as the company had done twice before, and the year-end accounts classified the bonds as non-current (correctly, since they matured beyond twelve months) and the $40,000,000 as current. The bond market closed in the spring; the company's rating was downgraded on weak results; and by the next year end the bonds, now due in two months, were current, unrefinanced, and the company's current ratio was 0.5.
The auditors qualified the accounts with a going concern emphasis; the share price halved; and the company refinanced the bonds with a secured facility from a specialist lender at a rate 4 points higher, with a $6,000,000 arrangement fee, in the final month before maturity. The board's review concluded that the treasurer had managed the maturity as a calendar event rather than a risk, that refinancing should have begun eighteen months ahead when the market was open, and that the maturity profile (a third of the debt in one year) had been imprudent. The company's new policy required refinancing to begin no later than eighteen months before any maturity above 10% of debt, and set a maximum of 20% of debt maturing in any year.
Watch out
Common mistakes.
- Leaving debt as non-current when a covenant was breached at the balance sheet date and the waiver came after it, which under IFRS misclassifies the whole loan.
- Relying on a refinancing completed after the balance sheet date to keep maturing debt non-current under IFRS, which does not permit it (US GAAP may, if the agreement is firm before issuance).
- Treating the current portion as a bookkeeping reclassification rather than a cash requirement that the forecast must fund and the refinancing plan must address.
Questions
People also ask.
Why does the classification matter if the debt is the same?
Because current liabilities drive liquidity ratios, working capital, covenant tests and the reader's view of what the company must pay in the coming year. A large current portion with no funding plan is a refinancing risk that the balance sheet is designed to reveal.
What happens to a loan when a covenant is breached?
The lender typically gains the right to demand repayment, which makes the loan current unless the lender has waived the breach for at least twelve months before the balance sheet date (IFRS) or before the statements are issued (US GAAP, with conditions). Waivers should be obtained before the test date, not after.
How should the current portion be managed?
Through the cash flow forecast (which must fund it), a maturity profile that limits how much falls due in any year, early refinancing (starting twelve to eighteen months ahead), and covenant monitoring with waivers sought in advance of any anticipated breach.
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