Wednesday, July 30, 2008

The Current Ratio: An Additional Thought

This is an add on to my last post.

Pretend you are a company that has a current ratio covenant and you expect to be out of compliance. You are going to try and bring yourself into compliance by using some of the cash you have on hand to pay off current debt.

Result: You bring yourself into compliance with your current ratio covenant. And you've decreased your cash at the same time. That doesn't make me feel better.

On the other hand, say you attack this by trying to accelerate collections on outstanding receivables. Done right, that can be a good thing. Done wrong, and it can be a nightmare. If you attack it by reducing inventories, that means (hopefully) that you are going to sell it. Which means more receivables.

Really, the only quick way to attack it is to use up cash. And your working capital is unchanged. Why is this better??

1 comment:

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