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Don't Become Over Reliant on the Current Ratios
By Michael C. Dennis M.B.A.,
C.B.F.
The current ratio provides and indication of the liquidity
of a business by comparing the dollar amount of current assets to
current liabilities. On a recent consulting assignment, I found that
the client was rejecting applicants with current ratios under a 1.25
to 1. The credit manager told me that the reason for the policy was
to 'weed out' applicants with cash flow problems. I made the following
comments and suggestions:
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I asked my client to consider the fact that it was the actual
timing of cash inflows and outflows that determined whether or
not a customer would be able to pay invoices when they came due.
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I asked them to view the current ratio is an indication of
a customer's liquidity. I suggested it was possible for a company
to have a low current ratio and have no trouble paying its bills.
One example of this would be a customer with a low current ratio
but a large working capital line of credit with its bank.
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It would be important to see how the applicant has paid and
is currently paying trade creditors. It is also important to
know how large a line of credit they need.
I asked them to consider the current ratio as one factor
in the decision making process, and not to disqualify applicants
based on only one financial ratio. |
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