Current Ratio

The current ratio is a way of looking at your working capital and measuring your short-term solvency. The ratio is in the format x:y, where x is the amount of all current assets and y is the amount of all current liabilities.

Generally, your current ratio shows the ability of your business to generate cash to meet its short-term obligations. A decline in this ratio can be attributable to an increase in short-term debt, a decrease in current assets, or a combination of both. Regardless of the reasons, a decline in this ratio means a reduced ability to generate cash.

 If you're looking to secure money via the sale of some stock through an initial public offering, many State Securities Bureaus will require that you have a current ratio of 2:1 or better.

Merely paying off some current liabilities can improve your current ratio.

 For example, if your business's current assets total \$60,000 (including \$30,000 cash) and your current liabilities total \$30,000, the current ratio is 2:1. Using half your cash to pay off half the current debt just prior to the balance sheet date improves this ratio to 3:1 (\$45,000 current assets to \$15,000 current liabilities).

If your business lacks the cash to reduce current debts, long-term borrowing to repay the short-term debt can also improve this ratio.

 For example, if your current assets total \$50,000 and your current liabilities total \$40,000, the poor 5:4 current ratio changes to a better 2:1 ratio if \$15,000 of long-term debt is used to refinance an equal amount of short-term debt (you'll now have \$50,000 in current assets to \$25,000 in current liabilities).

Other possibilities may suggest themselves if you carefully scrutinize the elements in the current asset and current liability sections of your company's balance sheet. The idea is simply to take steps to increase total current assets and/or decrease total current liabilities as of the balance sheet date. For example, can you place a higher value on your year-end inventory? Can pending orders be invoiced and placed on your books sooner to increase your accounts receivable? Can purchases be delayed to reduce accounts payable?