By: Ruth King
“We don’t have enough money in our bank account to cover payroll.”
This is NOT what you want to hear from your bookkeeper the day before payroll is due.
The warning signs of an impending cash flow crisis are in your financial statements – you can fix them before they occur…when you pay attention.
Here are the signs…most of the time:
1. Your current ratio is decreasing. Current ratio is current assets divided by current liabilities, ie things that are cash or turned into cash within a year divided by bills that have to be paid within a year.
Decreasing current ratio generally means decreasing ability to pay your bills and decreasing profitability. Find out why your company is becoming less profitable and fix the issue.
If your current ratio is under one – you ARE in a cash crisis – you can’t cover your bills with current assets – the only way out is profitable sales.
2. Your Receivable Days are increasing. This ratio tracks the number of days from the time you send out an invoice to the time you get paid.
If you’re a commercial contractor and you’ve just sent out huge invoices, then yes, this ratio will increase for a short period of time. It should go “back to normal.” Also, don’t include retainage.
If you are mainly a COD contractor, this ratio MUST be less than 30 days, preferably less than 20 days. If receivable days increases from 5 to 10 days, that is a week longer to get your money. Why?
3. Your acid test is decreasing. This ratio is current assets minus inventory. Then take this sum and divide it by current liabilities.
If this ratio is less than half the current ratio (i.e. your current ratio is 2 and your acid test is less than 1) – you have too much money tied up in inventory.
If this ratio is decreasing and the current ratio is increasing you are building up inventory – a cash drain.
These are three quick and easy ways to discover that you might be headed for a cash flow crisis. Fix the issues and avoid the crisis.
Ruth King is known globally as the “Profitability Master,” and is a a thought leader in entrepreneurship and business. Her books have been recognized as among the greatest in numerous industries. Learn more about all her business activities here.