Health Check: Taking Your Pulse

At this time of year, many small businesses are busy preparing/finalizing their year-end financial statements for tax purposes, for submissions to other parties (e.g. regulatory bodies), and for some, to measure the state of their companies. Periodically monitoring the health of your business is always a good practice, especially during these recessionary times. It may give you some real insights into your business, help you identify any problem areas and focus and plan for the future.

We’ve put together some key “health check” indicators that you can easily calculate which will enable you to take a pulse of your business, which we will discuss over the next few series of posts. The numbers used in the following calculations can be obtained from your financial statements, and in many cases from the reports you create in the Merang TravelOffice system. This is not an extensive list of all financial ratios available (you can do a google search to get more) but just some basic ones we thought would be useful.

Let’s get started with “Liquidity Ratios”.

What does it mean:
They are a set of calculations (financial metrics) that will give you an indication of your company’s ability to meet short-term debt obligations. Basically, this is done by comparing your company’s ‘liquid’ assets (i.e. cash, or those easily converted to cash, such as short term investments, accounts receivable, and other ‘current assets’) to your short-term (or current) liabilities. This information is available on your balance sheet.

Generally, the higher the value of the ratios means that your company has a larger margin of safety to cover these short-term debt obligations (i.e. the “healthier” you company is). A higher value means that you will be able to pay your short-term debts as they come due. A low value means that you will have a more difficult time paying your short-term debts and meeting the running/operating costs of your business.

We will present here three types of liquidity ratios:current ratio, quick ratio, and cash ratio:

Current Ratio measures the short-term solvency of your business.

Current Ratio = Current Assets / Current Liabilities

Quick Ratio is a measure of your company’s ability to pay short-term debts instantly.

Quick Ratio = (Cash + Accounts Receivable) / Current Liabilities
Quick Ratio = (Current Assets – Inventory) / Current Liabilities
(as travel businesses probably would not have any inventory, the first calculation is more useful).

Cash Ratio is very similar to the quick ratio, except it only includes cash or cash equivalents (e.g. short-term or marketable investments) in the calculation. It is again a measure of the ability to pay off short-term debts immediately, but is more conservative than the Quick Ratio.

Cash Ratio = (Cash + Marketable Securities) / Current Liabilities

Again, there may be other Liquidity ratios that you could also use. But we hope you find these basic ones useful. Over the next few posts, we will provide some other types of ratios that you may be able to use.