How to Think Like Benjamin Graham and Invest Like Warren Buffett

RecognizingSuccess 121

short term obligations such as commercial paper that is later refi-
nance dwith long-term obligations such as bank loans. This can also
produce low or negative working capital while not posing any threat
to the company’s short-term ability to meet its obligations.
Ben Graham put it this way in his marvelous little book pub-
lishe din 1937,The Interpretation of Financial Statements:

The proper amount of working capital require dby a particular

enterprise will depend upon both the amount and the character

of its business. The chief point of comparison is the amount of

working capital per dollar of sales. A company doing business

for cash an denjoying a rapi dturnover of inventory—for exam-

ple, a chain grocery enterprise—needs a much lower working

capital compare dwith sales than does the manufacturer of

heavy machinery sol don long-term payments.^2

Current and Quick Ratios

Evaluating the working capital position is achieve dby comparing the
relationship between current assets an dcurrent liabilities in relative
terms. Known as thecurrent ratio, this relationship shows how many
dollars in cash or other assets likely to be turned into cash within a
year are available to pay debts that are due within that year. As a
rule of thumb, for most businesses the ideal current ratio is around
1.5, but the range of current ratios across companies an din dustries
is broad.
A current ratio substantially higher—say, 3 or 4 or more—is a
sign of potential problems, not with respect to liquidity but with
respect to efficiency. It implies that there are financial resources that
coul dbe free dup an dput to better use: Inventory coul dbe re duce d,
receivables coul dbe collecte dmore quickly or sol d, or payables
coul dbe age da bit more before being pai d.
At the other extreme, a current ratio of 1 or less (i.e., negative
working capital) is often a warning signal that a company may face
difficulties in paying its debts as they come due in the short term.
As the ratio gets close to 1 or below it, therefore, investigate the
liquidity question further.
Recently the average current ratio of the companies in the S&P
500 was about 1.5, about the same as for the conglomerate segment
of that index, of which GE is a part. The current ratio in the com-
puter industry tends to be higher, closer to 2.75 (with Microsoft right
aroun dthat average). Specialty retailers, inclu ding Amazon.com, ha d