Who’s Watching Your Working Capital?

Turn on the news and you’ll see companies everywhere trying to shore up their balance sheets in anticipation of weak sales and reduced access to credit. Adequate working capital is crucial in these tough times to stay in business.

My predecessor, Ren Garcia, has given us a nice portrayal of a business wimp as one without enough working capital. And Randy Meyers at CFO Magazine has warned that the temptation to extend payments is a sign of working capital trouble.

Here’s how to keep an eye on yours!

Working Capital and Related Ratios

Working capital is defined as the amount of current assets minus the amount of current liabilities on the balance sheet as of certain date. If you’re showing current assets of $100,000 and current liabilities of $80,000, your working capital is $20,000.

While any current assets are great, cash is better – especially now! Cash flow troubles can develop quickly if current assets are not converting regularly to cash. If there are receivables going unpaid or inventory that’s not selling, you could end up with a deceiving working capital figure.

Key ratios to analyze include:

• Current Ratio: Current Assets/Current Liabilities (1.5 is good)
• Quick Ratio: (Current Assets – Inventories)/Current liabilities (1 is good)
• A/R Turnover Ratio: Sales/Average Accounts Receivable
• Inventory Turnover Ratio: Cost of Goods Sold/Average Inventory (the higher the better)
• Days Sales in Inventory
• Day Sales in A/R

Whether you use the ratios to keep a close eye on the cash coming into your own business or one you want to invest in, they’ll serve you well.

Image Credit: Brooks Elliott, Flickr