WORKING CAPITAL RATIO
The working capital ratio is a ratio of how many times you could pay your bills with what you either have in the bank, or expect to receive in a short time. It is expressed as a ratio, hence the name, by dividing the current assets by the current liabilities. Current assets are what you expect to turn into cash within a short time, usually a year. Current liabilities are what you expect to use the cash for, such as bills, note payments, equipment payments, within a short time period, again, usually one year.
If your ratio is 1:1, then what you expect to have available to pay your bills is exactly what you expect your bills to be. There will be nothing left over for future growth needs. A lower ratio means you will probably not be able to meet your bills, while a higher ratio will mean that your cash balances will build. This may mean you have cash to expand, and this is one reason that this ratio is very important to you as a small business. It also has a lot to do with your interest expenses, which can be very high.
The amount of money that you need to cover all costs consisting of lease, leases, mortgages, payroll, stock, incidentals and materials is called your “minimum working capital demand”. You can determine it as a weekly, month-to-month, or annual number. You should know what it is for your business and your industry. Not knowing means that you are basically flying without instruments, ready to crash eventually.
We can show you ways to improve and monitor the working capital ratio for your business.
LET VAUGHNCPA BE YOUR TAX CONSULTANT; ACCOUNTANT; and ADVISOR. CALL US AT 505-828-0900.