Your business wants to tell you exactly how to succeed. The only problem is, it doesn’t speak English. But it does speak numbers.
So, for starters, let’s look at what your Balance Sheet tells us about your ability to pay your bills on time, which is called liquidity. And for that we look at Current Assets and Current Liabilities.
Current is defined as “within 12 months”. So, current assets, mostly accounts receivable and inventory, are assets that will turn into cash within 12 months. Current liabilities, mostly accounts payable and notes payable, are debts that you’ll have to pay within 12 months.
To get a read on your company’s liquidity, divide current assets by current liabilities. If you have $1.5 million in current assets and $1 million in current liabilities, the ratio is 1.5 to 1. A positive ratio means you have more cash coming available in the next 12 months than need for cash. A ratio of 1.5 to 1 is good. 2 to 1 is better.
Keep track of your current ratio, include it in your monthly reporting and take steps to get it where it needs to be.
Next time I’ll explain the Quick Ratio, a more conservative version of the Current Ratio, that takes Inventory out of the equation. Stay tuned.