Managing cash flow is crucial to your success as a small business owner. Therefore, ensuring enough cash to meet your obligations is a key priority. This is where the current ratio comes in handy as a financial metric to help you manage your cash resources.
Calculating Current Ratio
You must divide your current assets by your current liabilities to calculate your current ratio. The goal is a result greater than 1, indicating you have enough current assets to cover any upcoming obligations. Ideally, it would be best to aim for a current ratio of 2:1, which is considered ideal.
So, what exactly are your current assets? Generally, your current assets consist of your cash and accounts receivables. If you have inventory, those count as current assets as well. On the other hand, your current liabilities are usually your accounts payable, credit card balances, and other payables, such as sales tax, that you need to make in the next 12 months.
The Current Ratio is a Reflection of Cash Flow
By calculating your current ratio, you can determine how strong your working cash flow is and how much risk your business has regarding meeting your upcoming obligations. For example, if your current ratio is less than 1, your business may have difficulty meeting its short-term obligations. However, if your current ratio is 2:1 or more, your business has a strong cash position.
If you’re facing challenges in managing your cash flow or need help improving your current ratio, our friends at ZümiFi can help. Their financial experts can provide you with insights and advice on improving your cash flow and managing your working capital more effectively.
A Signal to Grow
On the other hand, if your current ratio is 2:1 or more, you may want to start thinking about your cash reserves policy and how best to use your strong cash position to grow your business. A strong cash position gives you the flexibility to invest in new projects or expand your operations, providing your business with a competitive edge in the market.