Do You Know Your Quick Ratio?

Have you looked at your year-ending 2021 balance sheet? Among other things, it shows your current liabilities and your current assets. There is a financial ratio we look at as just one way or just part of the way to put together a picture of the financial health of a company which is called The Quick Ratio. Keeping an eye on this financial ratio may be more important than one thinks. It may help to keep an owner from being blindsided by financial trouble. The quick ratio measures the dollar amount of liquid assets available against the dollar amount of current liabilities of a company. Liquid assets are those current assets that are cash or that can be quickly converted into cash. Although inventory and receivables are part of your current assets, they may not be converted into cash as quickly as one might think. This brings up another ratio that an owner may want to know more about which is the average days to collect. That is also important to know but another conversation for now.

Current liabilities are a company's debts or obligations that are due to be paid to creditors within one year/the next 12 months. To get the quick ratio, we divide the current assets mentioned above by the current liabilities. A result of 1 is considered to be the normal quick ratio. Again, be careful about including your inventory and your receivables in calculating the Quick Ratio. However, a ratio of 1:1 indicates that the company is fully equipped with exactly enough assets to be instantly liquidated (the word "instantly" is key) to pay off its current liabilities. A company that has a quick ratio of less than 1 may not be able to fully pay off its current liabilities in the short term, while a company having a quick ratio higher than 1 can instantly get rid of its current liabilities. For instance, a quick ratio of 1.5 indicates that a company has $1.50 of liquid assets available to cover each $1 of its current liabilities. A quick ratio of.56 to 1 means you have 56 cents of liquid assets to cover each $1 of current liabilities which, of course, means this needs to be worked on. Just some of the things that can done that will get a company to at least that 1 to 1 ratio are:

-Growing the company with recurring revenue.

-Install a pricing strategy and rate card that purposefully targets a specific profit margin and affords a service company to be able to profitably deliver great service.

-Practice pricing integrity.

-Reasonably raising some current prices, especially those that are obviously too low, and through your marketing and advertising campaigns, target the demographic and customer base you want to build. We call this "targeting the profitable customer and tagging the unprofitable customer". The unprofitable customer may be the result of the pricing strategy of the company.

-Paying your team at least partially based on performance. This also enables an employee to have the potential to earn more as they produce more.

-Have a diversified customer base. Never, for example, have an unhealthy amount of your revenue dependent on a handful of customers. I have known companies whose revenue was basically dependent on one or two major accounts and when the company lost those accounts, they went belly-up or nearly insolvent.

-Have cost control systems and asset protection systems in place to preserve cash and increase your current assets.

The Quick Ratio calculation is also dependent on a properly structured Balance Sheet to be calculated accurately.

To know more, contact us at The Clendenin Consulting Group for a confidential conversation at gc@clendenincg.com or text us at 407-948-0897.