2 Financial Ratios You Must Know

 
 

 

Cash Flow Roller Coaster

Most small businesses have seasonality or peaks and valleys in their cash flows, which demand that you plan ahead to avoid a cash shortfall. 

Are your current results skewed by seasonality or a special circumstance?  If the results show a need to achieve better cash strength, you may need to consider special cash flow budgeting and how you can obtain short term working capital.

 

 

 

Signals of an Unseen Problem

Your business may be strong as an ox, but what if you had a ratio that could give you an early warning sign that you were headed for financial trouble?  Business owners who’ve taken their companies through bankruptcy certainly wish they’d had a way to see their problems while they had time to respond.  The Cash Flow to Debt Ratio is an important ratio for gaining an advance warning that you need to make strategic changes and prepare for rough financial times. Experts tell us that this ratio can predict trouble up to 3 years prior to bankruptcy. 

This is an important indicator of your company’s ability to pay its principal and interest on debt through the cash generated by operations, or in other words, it shows you how long it would take to pay off all your debt if all cash flows were dedicated solely to debt repayment.

The thought of a discussion of financial ratios sends most business owners fleeing.  So, go for a quick jog around the office.  

Now gather your composure and give me 5 minutes.   

You need this and I’ve made it easy for you by focusing on the two most important ratios to gauge the health of your business.  If you’re arguing the point, then you like financial ratios and you don’t need this advice!

As a busy business owner, your primary barometers may be “gut feel” and the cash balance in your operating account.  And your gut feel may not be wrong, but with this approach, you really don’t have enough information to adjust your activities.  No benchmarks.  

Let’s take the effort up just one notch, and in so doing, give yourself the ability to see cash flow problems before they become difficult to manage.  The two ratios I’ll share are the equivalent of shelter and food in Maslow’s hierarchy of needs.  You have to survive before you can thrive.  


Quick Ratio.jpg

The Quick Ratio is the first financial ratio you should become familiar with, and is very simple to compute.  This ratio tells you whether you have enough cash or assets that can be quickly turned into cash in order to cover your day to day operating needs.


...can signal financial distress while you still have time to respond.

...can signal financial distress while you still have time to respond.

 

 

 

Note:

 An impending loan maturity date must be taken into account, as the ratio assumes ratable principal payments rather than a one-time balloon payment.