As a small business owner it is critical that you understand how your business is performing financially. Some times looking at financial statements when you are not a non-finance person can be such a headache. The key is to know how to take specific information from your financial reports and calculate your financial ratio's.
These ratio's are measuring the liquidity of your business. These ratio's deal with how you can meet all of your short term debt.
Current Ratio = Current Assets / Current Liabilities (this ratio shows your ability to pay short term debt)
Quick Ratio = Quick Assets / Current Liabilities (Quick Assets = Current Assets - Inventories)
Net Working Capital Ratio = Net Working Capital / Total Assets (NWC = Current Assets - Current Liabilities)
Know lets do some calculations.
Current Ratio Calculation
Current Assets = $10,000.00
Current Liabilities = $6,500.00
Current Ratio = $10,000.00 / $6,500.00 = 1.53 So we express the ratio as 1.53 : 1. This means for every $1.00 of debt, you have $1.53 of assets. This is a good thing. This means that you have enough short term assets to pay your short term debts if the demand was made.
Lets try another one
Current Ratio Calculation
Current Assets = $100,000.00
Current Liabilities - $123,000.00
Current Ratio = $100,000.00 / $123,000.00 = .83. So what does this mean? .83:1? This means that for every $1.00 of debt, you only have .83 cents. This is not so good. This means that you cannot pay all of your short term debt if the demand was made.
Ratio's can help you understand the financial position of your business. Try calculating your ratio's the next time you have your financial statements in front of you.
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