Capital Ratios: Operating/Liquidity
February 11th, 2010
Copyright © 2010 Integrated Profitability TM
Capital ratios that concentrate on operating/liquidity relationships are primarily focused on the immediate and short-term operation of the business. Operating ratios help owners track their ability to meet short-term obligations. These (balance sheet) ratios are complementary to the following, income statement, items:
● Cash flow
● Daily and/or ongoing liquidity
The purpose of these particular ratios is to monitor the company’s ability to keep the business afloat in the short-run. Depending on how fast cash is being spent and received, operating ratios can also help forecast how long before running into operating (solvency) problems.
The major operating ratios are*1:
1. Current Ratio
Current ratio = current assets / current liabilities
Measures whether current liabilities will be paid from current assets. A ratio of 1.0 is breakeven; higher is better.
2. Quick Ratio (Acid Test)
Quick Ratio = (current assets – inventory) / current liabilities
Measures whether the most liquid assets will be sufficient to pay current liabilities
(Note:
Current assets include cash, marketable securities, accounts receivables and inventory
Current liabilities include accounts payable, short-term notes payable, current maturities of long-term debt, and accrued expenses & income taxes)
Here is a useful website:
If your business is small enough, you probably carry these ratios around in your head. And deal with them every day. Still, when all goes well and your business grows, you will have much more important things to work on. Regularly reported operating ratios will be an ongoing connection to how well your expanding business is doing in this critical area.
Bill
William A. Stong
Email: william.a.stong@gmail.com
SBF&P # 53
Telephone: 925-202-6244
Copyright © 2010 Integrated Profitability TM
*1: Eugene F. Brigham, Fundamentals of Financial Management (Illinois: Dryden Press, 1978) p. 125.
In the News: Two Faces of IOUs
July 16th, 2009
Copyright © 2009 Integrated Profitability TM
Regarding California’s IOUs, there are two more articles in the Contra Costa Times of interest, with the second one being particularly pertinent to the current “Small Business Finance & Profitability” (SBF&P) series on cash flow.
The first article, “Options dwindle for those holding California IOUs” was on page AA1 on Tuesday; July 14, 2009. Taking a more professorial approach, the spokesman for the California treasurer’s office sheds slightly more useful light on the sad financial plight of the State of California:
““The decision by most major banks to not accept IOUs makes them less liquid, makes it more difficult to turn them into cash,” said Tom Dresslar, spokesman for the state treasurer’s office.”
Both phrases say the same thing and he still manages to make it sound like the banks are somehow causing the problem. It would be nice to hear him say that the State of California….well, let’s be honest. It’s not really the State of California that’s the problem: it’s the elected officials who have the job to balance the state’s budget and to manage the state’s financial condition. They aren’t doing either.
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