Financial Management 101. Angie Mohr

you,” Vivian said.

      “But our terms are net 30. That sounds like it’s a problem.” Joe picked up the paper and examined it closely.

      “Now we’ll be able to figure out when we do have problems like this,” Becky said. “Vivian, how can we correct the accounts receivable problem?”

      Vivian said, “First, let’s take some time and examine some of your other key ratios. Then we’ll have a better picture of all the issues we need to manage.”

      When Good Ratios Go Bad: What to Do When There’s a Problem

      Okay, so you have chosen the important ratios you want your business to track and you are tracking them on a quarterly basis. In the third quarter, three of the ratios seem out of kilter. What do you do? How do you know what’s going wrong?

      Here is a quick guide to the questions you need to ask yourself and your team if your ratios seem to be deteriorating.

       Solvency or liquidity ratios:

      • Do I have too much debt?

      • Are my debt repayment terms too hard on cash flow?

      • Am I getting behind on my payments to my suppliers?

       Asset and debt management ratios:

      • Am I buying too much inventory?

      • Am I collecting my receivables on time?

      • Can I stretch out my payables without causing harm to my supplier relationships?

       Profitability ratios

      • Are my expenses under control?

      • Do I have a lot of excess cash in my account?

      • Have my sales dropped and why?

      After three or four quarters of tracking your ratios, you will have a much better understanding of your business: its cycles, its cash flow patterns, and its idiosyncrasies. Only once you understand your business on this level can you really start to grow!

      Chapter Summary

      • Solvency ratios measure your business’s ability to meet its debt obligations.

      • Asset and debt management ratios measure how your business manages its resources to generate sales.

      • Profitability ratios measure how effectively you are able to use those resources to produce profit.

      • Ratios are most useful when compared over time.

       Table 1: A Quick Reference to Ratios