Profitable businesses go bankrupt all the time. All that needs to happen is a few missed payments due to accounts receivables and payables not lining up well.
Though the reasons may vary, growing companies often run into cash flow problems because they need increasing amounts of working capital to pay for the inventory and employees they need to grow.
The current ratio, also called the working capital ratio, can help you avoid this all-too-common pitfall.
What is a current ratio?
The current ratio is the difference between current assets and current liabilities. It measures your business’s ability to meet its short-term liabilities when they come due.
Current refers to money you need and use in your short-term operations. This means that working capital excludes long-term investments in fixed assets such as equipment and real estate.
Current assets include: cash, short-term investments, pre-paid expenses, accounts receivables and inventories.
Current liabilities include: credit card debt, accounts payable, bank operating credit, the portion of long-term debt expected to be repaid within one year, accrued expenses and taxes payable.
Benefits of keeping track
Keeping track of your working capital ratio will give you early warning signs when your business doesn’t have sufficient cash flow to meet current liabilities. It will also give you a better sense of how much liquidity you can devote to new opportunities and can help you attract better credit terms.
How to calculate the current ratio:
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