“What Do Financial Ratios Really Mean?” The Beal Business Advisor

Sep 9, 2011 | Corporate Member News

Over the next three newsletters, we will shed some light on common financial ratios used in financial analyses. Today, we will look at the “Current Ratio.”

The current ratio is mainly used to give an idea of the company’s liquidity position, a measure of whether or not a firm has enough resources to pay its short-term obligations over the next 12 months. It compares a firm’s current assets to its current liabilities. The current ratio can give a sense of the efficiency of a company’s operating cycle or its ability to turn its product into cash. 

The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point, however this ratio can vary greatly in different industries, therefore it is best to compare your ratio to an industry benchmark. 

Another liquidity ratio is the quick ratio. The quick ratio differs from the current ratio as it examines only the most liquid assets and liabilities. For example, it can take time to turn inventory into cash, therefore the ratio is often calculated as cash and accounts receivable divided by payables and any other short term debt that may come due immediately.   

There are a few ways a company can improve their liquidity position, such as: 

– Manage accounts receivables more effectively by taking action on overdue accounts. Bill customers more quickly in order to speed up the collection. Provide incentives to customers who pay early. Provide different credit terms to customers based upon their creditworthiness.

– Use as much trade credit or vendor financing as is reasonable/possible. It is typically free debt (in accounts payable) because it does not carry interest.  Set longer terms with suppliers.

– Keep inventory/supply levels as low as possible without adversely affecting the business.

– Improve efficiencies in the businesses’ operating cycle. Get the product to the customer faster and receive payment faster.

– Good income statement management helps balance sheet performance. Increase prices selectively where possible or reduce some overhead costs to improve profitability.

– Monitor financials and prepare budget forecasts in order to predict and prepare for potential cash shortfalls that may occur.     

– Sell unproductive assets that are not contributing sufficiently to the generation of income.       

– Relieve short-term debt pressures by moving it to a long-term debt if possible as this may lower cash payments.          

Sell receivables to collect funds faster. Although this may result in obtaining fewer funds than owed, it can be an effective way to strengthen the cash position of the company if you are in a crunch.    

For more information, contact us at 204-478-7266 x110. 

This article originally appeared in the September 2011 edition of The Beal Business Advisor. The issue also included:     

  • Buying a Business 
  • The Business Sales Process 
  • Quote of the Month 
  • Upcoming Seminars
  • Businesses for Sale 

Check it out here

About Beal Consultants, Business Growth Professionals

Focused Business Advisors
Beal Consultants helps people buy, sell, value, improve, and start businesses. We deliver value-added services in the following areas:

Grow Your Business
We can help make your business grow profitably using proven success strategies, step-by-step guidelines and an abundance of insight from our experience in working across a wide variety of industries.

Insightful Diagnostic Report

Are you ‘too close’ to your business? Are you working too hard in your business you have no time to work on it? Do you need a second perspective, a fresh pair of eyes?

Using a proven methodology, we can come in, interview you and your key staff, review your financial results against industry benchmarks, and make concrete recommendations on how to improve your business.

Improving your business means more profit for you, more free time and, eventually, more value when you exit. Call today for a free, no risk initial consultation.

Strategic Planning

Strategy planning is NOT about creating 50-page documents that are never referred to again. Strategic (and business) planning is all about understanding how your business can grow and thrive in a challenging, competitive business environment.

You are competing against many competitors, not just your direct competitors, but all your indirect competitors as well. You are vying for attention in an increasingly complex and crowded marketplace. You need to clearly understand – and you need to communicate to your clients – your key value proposition – why should they do business with you? Understanding your value proposition is key to differentiating yourself in today’s marketplace, and is key to having a sustainable competitive advantage. Your business strategy and business success relies on having a crystal clear understanding of your unique competitive advantage.

Find out more here.

About Beal Consultants – Business Brokers

Focused Business Advisors

Beal Consultants – Business Brokers helps people buy and sell businesses. We deliver value-added services in the following areas:

Buy a Business
We provide counsel, guidance and support throughout all steps of buying a business including: Search, Screening, Valuation, Negotiation, Due Diligence, Financing and Agreement Structuring.

Sell Your Business
We provide counsel, guidance and support throughout the process of selling a business. Some of the advantages of hiring an intermediary to sell your business include: confidentiality, creating and executing the marketing package, negotiation, and buyer screening.

Succession Planning/Exit Strategy
Looking to retire? Great! Is your business ready for you to retire? Can you afford to retire? Do you know how to minimize your tax burden when you are looking to sell or pass your business on to your children? We can help you understand the options that are available to you. Think it’s too early? The earlier you start, the more your business can be worth, and the more options you have to minimize taxes. If you’re thinking of getting out within five or less years, start planning today!

Business Valuation
Need to know what your business is worth? We help you determine the value of it and understand the key drivers of that value, so you can know how to improve it.

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