Yesterday I wrote about the importance of financial discipline, when it comes to your debt to equity ratio, using IBM as the example. It occurred to me this morning that as I examine accounting records of my business clients, both in and out of QuickBooks, there is another accounting measure that almost always needs improvement, and goes hand in hand with debt to equity. That is, your current ratio.
Current ratio is an accounting measure that compares your current assets to your current liabilities. Put simply, it’s a comparison of your bank account balances, added to your accounts receivable, along with the value of your inventory, compared to how much you owe in credit card debt, payroll taxes, bills to vendors and your line of credit. Ideally you should have two dollars of assets to one dollar of liability, which would be expressed as a current ratio of 2.
This measure is very important, considering the uncertainty of the economy, for two reasons. First, banks are scrutinizing this accounting ratio. I had lunch with a loan officer from a Raleigh bank a few months ago, and asked him what his loan committee considers important when deciding for or against a business loan request. He told me that applicants need to have a running history of current assets, above their industry peers. Your ability to “live within your means” in terms of money you owe to others (accounts payable), while having a healthy balance in your checking or savings account, is what’s being judged.
The second reason you need to improve upon your current ratio is precisely because of the economy we’re in. It’s like the old adage says, “whoever has the gold, makes the rules”. Before I even examine a QuickBooks file of a new client, I can usually tell by their level of confidence that they’ve got money in the bank. Almost everything is on sale in this economy and if you have money, you can move your business forward on the cheap.
If you have a negative current ratio (owe more money than you have in assets), or if the ratio is less than one to one, you should consider the simple savings advice I wrote about a couple of weeks ago, HERE. There are few things that will build your confidence more than accounting for a solid current ratio. If you managed to improve upon this, comment below and tell me how you did it.