“We didn’t get our financials for three months and now we’re in a cashflow crunch.”
Current Ratio is a measure of liquidity, i.e. how easily can your company pay its bills?
It also answers the question: is your company becoming more or less profitable.
Calculate this ratio by using figures from the balance sheet. The ratio is:
Current Assets/Current Liabilities
The current ratio answers the question, “Is your business liquid enough so that you can pay your bills on a timely basis?” Current assets are things that are cash or turned into cash within a year. Current liabilities are things that you have to pay within a year. Do not include owner receivables or payables which will not be repaid within a year. Check Robert Morris, Risk Management Association, or Dunn and Bradstreet for the average ratios in your industry.
A current ratio under 1.0 means your company is in a cash crisis. You don’t have enough current assets to turn into cash to pay all your current liabilities. To my knowledge, the only way out of a current ratio less than 1 is profitable sales…and a lot of them.
Assume that you calculate the current ratio and it is 1.95. Is that good or bad? It actually depends. If you take the standard industry ratio and it is 1.50, the ratio looks good. However you should compare the ratio to your previous month’s ratio. If the month before you had a current ratio of 2.05 and it went down to 1.95 this month, that’s not good because the ratio is trending the wrong way. Or, if the previous month was 1.65 and it went to 1.95 this month, your company is doing better. You are going in the right direction.
With these ratios you have to look at the trend. A single figure won’t tell you too much. Are the ratios going the right way or are the ratios going the wrong way?
Did you check your bank accounts on line today? This is the first step in protecting your hard earned cash.
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Ruth King is well known as “The Profitability Master.” She is passionate about helping small business owners become profitable and stay profitable. For over 40 years she has coached, trained, and helped contractors and others achieve the business growth and goals they wanted to achieve.
Contact Ruth by emailing ruthking@hvacchannel.tv.
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