Strategic Planning in the Small Business

HO 2-5

(continued)

Unit 2

Liquidity

Ratios

Financial

ratios

are computed

to provide

a more specific

picture

of

the business.

Initially,

a series of

liquidity ratios

may be

ex­

plored.

These ratios

indicate

the firm's

capacity

for meeting

its

short-run

or near-term

obligations.

In other

words, these

ratios

help

in determining

whether

the

business

has enough

working

capital

to get by,

pay its

bills, invest

in the future,

take

advantage

of immediate

opportunities,

and

fight off unforseen

short-run

crises.

Current

Ratio

The current

ratio

is derived

by dividing

current

assets

by current

liabilities.

This

is shown for

Waverly

Custom

2-6.

Obviously,

the

interpretation

of

this

Jewelers

in

Table

figure

is more

important

than

its computation.

Many

experts

feel

that a current

ratio of two-to-one

should

be present.

Yet,

this

is only a rough

rule

of thumb

and varies

considerably

from

industry

to industry.

It is

important,

though,

for some

bench­

one

mark

to be established.

For example,

if the

industry

is

where the

bulk of

sales are

on credit,

a larger

current ratio

may

be needed

to feel comfortable.

As noted

earlier,

industry

ex­

pectations,

as well as

selected financial

ratios

of industry

leaders,

can

be attained

from

readily available

outside

reference

sources.

For

our sample

company,

it may

be useful

to comment

on the

changes

that have

occurred

in the

current ratio

over the

years.

At the

end of year

one the

ratio was

below

the rough

rule of

thumb

of two to

one. It

improved

in year two

largely

because

long-term

debt was

substituted

for short-term

debt which

was

substituted

for short-term

payables.

By year four,

the ratio

is

Comparative

Current

Ratios

Table 2-6

Current

Assets

Current

Liabilities"

Year 1

Year ,

Year 3

Year 2

221,500

202,200

186,300

144,000

49,000

67,000

84,800

93,700

4.5 to1

3.1 to1

2.2 to1 1.54to1

66

PartOne

The Analysis

Phase

209