Is Your Business “Healthy”? The One Number You Need to Know

We often talk about profit, but there is a much more important metric (or KPI) that helps you determine the true health of your business: The Current Ratio.

If you aren’t an accountant, the word “current” might sound vague. In the world of finance, “current” simply refers to things that are going to happen between today and the next 12 months.

Breaking Down the Math

To understand your ratio, you need to look at two things:

• Current Assets: This is the cash you have in the bank or the “receivables” (money customers owe you) that you expect to collect within the next year.

• Current Liabilities: This is the money you owe to your vendors and lenders between now and the next 12 months.

When you divide your current liabilities into your current assets, you get your ratio.

What Your Number Says About You

• The Number is 1: This is a very healthy place to be. It means for every dollar you’ve promised to a lender or vendor, you have a dollar ready to cover it.

• The Number is 2: You’re in great shape: you have $2 in the bank for every dollar you owe.

• The Number is Less Than 1: This is where the trouble starts. We call this an insolvent business.

The Scary Truth: Profitable but Broke

Insolvency is a scary term and a stressful situation. It means that for every dollar you owe, you have less than a dollar in the bank to pay it.

Here is the kicker: A business can be profitable and insolvent at the same time.

When you look at your “accrual” information, your business might show a profit. However, if you are insolvent, you are dangerously dependent on the timing of your collections. As a business owner, you’ll know you’re in this trap if the money coming in immediately goes back out the door because someone is already calling for it.

The Bottom Line: Don’t just check your profits: check your ratio. Knowing if you’re “current” is the best way to keep the stress away.