What's your company's Current Ratio?

Remember the idiom, "Don't put all your eggs in one basket"? That classic saying applies to all areas of business, including accounting. Knowing the latest technology is beneficial to running your business, but don't forget that having a firm grasp on accounting basics is essential.

To better understand your company's financial stability, you need to understand your company's current ratio. Simply put, your current ratio (also commonly referred to as liquidity ratio, cash asset ratio, and cash ratio) tells you whether or not you have enough resources to pay your bills over the next 12 months.

Calculating your current ratio is easier than it may seem, you simply take your company's total current assets (cash, short term investments, accounts receivable and inventory) and divide it by the total current liabilities (accounts payable, wages and salaries payable and accrued taxes, along with other liabilities).

Let's say your company has $75,000 in assets and $60,000 in liabilities. That means that for every $1 your company owes, you have $1.25 in assets.

Ideally, your company should have $2 in current assets for every $1 in current liabilities, or a current ratio of 2:1. The higher your ratio, that more liquid your company is; meaning that your assets are easily converted into cash.

The key to running a great business is to be proactive, knowing your current ratio can help detect problems. A ratio that is less than 1 can be dangerous. It could mean that your company may not be able to pay off all of its debts.

It may seem like having a ratio greater than 2:1 would be great for your company but it could mean that your business may have some underlying problems. Having a ratio that is too high can mean that your company might have an excessive amount of inventory or that you have customers who have balances in accounts receivable when they still have yet to pay their bill. Checking your current ratio is simple and taking the time to do it on a regular basis can help you foresee problems your company might face. Don't put all your eggs in one basket; new technology is great, but so is good old-fashioned know-how.