Investors, managers, business owners and other stakeholders use financial ratios to measure the performance of companies. The current asset ratio, or working capital ratio, is one commonly used tool that measures the liquidity and financial position of a company. It is calculated by adding up all of the company’s current assets and dividing them by the total amount of the company’s current liabilities. This ratio is used to determine how well a company is able to pay its obligations.
Understand what short-term means. Short-term assets refer to assets that are very liquid. Assets are things a company owns that have value. If an asset is short-term, it means the company can easily turn the asset to cash in one year or less. Short-term assets include cash, supplies and accounts receivable. Accounts receivable is an account that tracks amounts owed to the company. Short-term liabilities refer to amounts the company owes to other businesses or individuals that are due within one year or less.
Calculate the current asset ratio. Before you can try improving this ratio, you must know what your company’s current asset ratio is. Add up all current assets and divide this amount by the total of all current liabilities. A ratio of two or higher is considered good. Companies with ratios of two or higher are often more likely to have fewer issues paying their debts.
Pay off some of the current liabilities. For example, if your company has $50,000 in current assets, with $30,000 in cash, and $35,000 in current liabilities, the current ratio is 1.4. To improve this, consider using some of the cash to pay off the debts. If you use $20,000 of the cash to pay off debts, the ratio changes to $30,000 in current assets divided by $15,000 in current liabilities, resulting in a current ratio of 2.
Pay off as much debt as possible. If you want to improve the current ratio by using all your cash to pay off debt in the example, the current asset ratio would improve to 4. This is calculated by using the full $30,000 in cash to pay off the debt, leaving only $5,000 in debt. This leaves $20,000 in current assets divided by $5,000 in debt, causing the current ratio to significantly improve.
Take out long-term debt. Another way to improve the current ratio is to take a long-term loan for all of the current debt. By doing this, the current liabilities are completed eliminated which results in a terrific current asset ratio. The debt; however, is still there, but will be paid over a longer timespan.
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