How healthy is your business debt?
How healthy is your business debt? - The question needs to be asked by entrepreneurs who rely on financing from banks or other parties to develop their businesses.
Regarding debt in business, there are indeed two different principles. The first principle is that to be able to grow, a company needs to be in debt - rather than losing the opportunity or momentum in their business. The second principle is to try to avoid debt as much as possible, be very careful because debt for them is a risk.
Whatever principle you adhere to, we hopes that you can have indicators that show when your business debt is healthy and under control.
Current Ratio
When a company is unable to fulfill their financial obligations, for example:
- cannot pay operational bills (electricity, office rent, etc.)
- can't pay supplier bills
- cannot pay bank installments
then the company is called illiquid. Such difficult conditions can end in bankruptcy.
To prevent debt health conditions, wise entrepreneurs pay close attention to their liquidity ratios or financial current ratios.
The term liquidity used here refers to the condition in which a company's assets can be immediately converted into cash flow to pay its financial obligations.
How to calculate the current ratio?
If you have a balance sheet, calculating Current Ratio or Liquid Ratio is not too complicated to do:
FLIX company balance sheets in January 2019, Feb 2019 and Mar 2019 show the total current assets as follows:
- January 2019 - Current Assets:$ 528,000,000
- February 2019 - Current Assets: $ 585,00,000
- March 2019 - Current Assets: $ 647,000,000
Meanwhile, in the same balance sheet, the total current debt in the Passiva column is as follows:
- January 2019: $ 450,000,000
- February 2019: $ 575,000,000
- March 2019: $ 632,000,000
Thus, the Current Ratio or Liquidity Ratio of the FLIX company is as follows:
- January 2019: 1.17
- February 2019: 1.02
- March 2019: 1.02
It Means, FLIX Company ...
- Have $ 1.17 for every $ 1.00 in January 2019,
- Have $ 1.02 for every $ 1.00 in debt in January 2019, and
- Have $ 1.02 for every $ 1.00 in January 2019
What does Current Ratio mean from the example above?
Liquidity Ratios or Current Ratios have different emphases from different industries.
For example, if your business is consumer goods with continuous inflow of cashflow - the "fitting" liquidity ratio can still be said to be healthy. But if your business has a long production time and sales cycle, a larger Liquidity Ratio needs to be your goal.
What standard should I target for the Current Ratio?
Have a Current Ratio or a bigger Liquidity Ratio than last year. If possible, target to have a minimum Current Ratio at level 1.5. The greater your Current Ratio, the more peace of mind you have to think about your business development and innovation.
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