In this second of five postings we pick up where we left off and cover what a Current Ratio is. It is important to remember that these postings are meant to be a guidelines for SME businesses to consider and specific details change from business to business and market to market. We also offer SME businesses a FREE Business Health Check to give them a starting point for understanding what they can be doing to help their business do more.
A Current Ratio is similar to a Quick Ratio (as covered in the previous post) but is not centered around cash as much as it is centered around the comparison of your assets and liabilities. The formula for the Current Ratio is:
Current Ratio = Current Assets / Current Liabilities
For every $1.00 of Current Liabilities you should have at least $1.00 of Current Liabilities. To the extent that your Current Liabilities exceed your Current Assets, your business may be experiencing:
– your business has borrowed to grow and has not produced enough of a result to cover its obligations
– creditors may have a greater interest in your business than you do
– a business is not collecting on its receivables in a timely fashion
Banks and lenders like to see a Current Ratio of at least 1.25:1 which means that for every $1.00 of Current Liabilities they want to see $1.25 of Current Assets.
If the Current Ratio for your business is not changing over time or is getting worse you may need to take drastic steps to plan for a turn around. Between the Quick Ratio and Current Ratio you should be getting a good idea of how your business is using its cash flow and where the pressure points are. We have covered 2 of the 5 financial measurements available in our FREE Business Health Check and will continue with a Debt Ratio discussion in our next post.