Accountant In Indianapolis Discusses –
3 Ways To Determine If Your Business Is Liquid
One of the most important determinations that you should make – periodically – about your business is whether or not you are liquid. Being liquid is necessary to maintain business operations. And often, if you pay attention to the financial indicators, you can correct liquidity issues before they cost you significantly.
To determine if your business is liquid, there are a few financial ratios that you can use. The following are three simple methods of evaluation:
- The Current Ratio – current assets divided by current liabilities. This ratio is usually considered to be healthy if you have $2 in current assets for every $1 in current liabilities. However, certain situations create the need to maintain it even higher – such as when it’s difficult to borrow money from the bank for unexpected shortages.
- The Quick Ratio – The quick ratio is like the current ratio, except it excludes inventory and prepaid expenses. In other words, it only includes those assets that are most quickly converted into cash – cash, marketable securities, accounts receivable, etc. A healthy ratio here would be at least one to one.
- Accounts Receivable (AR) Turnover – credit sales divided by average accounts receivable. Of course, this ratio is only relevant if you maintain AR in your business. If this is the case, the ratio above will indicate how fast you are collecting from customers. Obviously, the faster the better. And also, if you divide the turnover by 365, you’ll know how many days it is taking to collect money owed to you.
From evaluating these ratios – aside from knowing if you are liquid – you can find out some valuable information about your business.
For example, you may need to borrow some funds from a bank to cover cash shortages that are causing the problem. Or, you might have money tied up in excessive inventory that can be invested elsewhere for a return.
Finally, to calculate these ratios for your business, your finances must be in order. Accounts need to be classified correctly, and your books must also be up-to-date.
If you need any further guidance concerning methods of evaluating your business, contact Larry Marietta, CPA.