Important Balance Sheet Ratios measure liquidity and solvency (a business’s ability to pay its bills as they come due) and leverage (the extent to which the business is dependent on creditors’ funding). They include the following ratios:
Liquidity Ratios.
These ratios indicate the ease of turning assets into cash. They include the Current Ratio, Quick Ratio, and Working Capital. Current Ratios. The Current Ratio is one of the best known measures of financial strength. It is figured as shown below:
Total Current Assets
Current Ratio = ————————-
Total Current Liabilities
The main question this ratio addresses is: “Does your business have enough current assets to meet the payment schedule of its current debts with a margin of safety for possible losses in current assets, such as inventory shrinkage or collectable accounts?” A generally acceptable current ratio is 2 to 1. But whether or not a specific ratio is satisfactory depends on the nature of the business and the characteristics of its current assets and liabilities. The minimum acceptable current ratio is obviously 1:1, but that relationship is usually playing it too close for comfort.
If you decide your business’s current ratio is too low, you may be able to raise it by:
- Paying some debts.
- Increasing your current assets from loans or other borrowings with a maturity of more than one year.
- Converting noncurrent assets into current assets.
- Increasing your current assets from new equity contributions.
- Putting profits back into the business.
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