Current assets: P150,000
Current liabilities: P100,000
Current ratio: P150,000 ÷ P100,000 = 1.5
This means that for every P1.50 worth of cash, receivables, and inventory in your current assets, you have P1.00 worth of payables. This may seem good at first, but as a rule, a current ratio of at least 2 is preferable. This means that for every peso that you need to pay, you have P2 in store or in your current assets.
Generally, the higher the current ratio is, the stronger the financial position of your company. This, however, is not an indication that you are managing your resources efficiently. For example, you may have accumulated so much cash in your bank account, thus increasing your current ratio. This may mean that you may be very financially liquid—you have so much cash—but you may not be maximizing your opportunities to earn. Indeed, you could have invested that extra cash in another business or in a high interest-bearing money-market investment.
Leverage ratios. After evaluating liquidity, you need to analyze the extent to which your business relies on other people’s money to finance its investments and operations. The leverage ratios are your tools for doing this type of analysis.
The leverage ratio measures the degree of financial risk you are taking in doing your business. The higher the risk is, the greater the probability of huge losses if your sales projections are not achieved.
One example of leverage ratio is the debt ratio, which measures the percentage of your debt in relation to your total assets.To illustrate, take the following example:
Total debt: P750,000
Total assets: P1,000,000
Debt ratio: P750,000 ÷ P1,000,000 = 0.75 or 75 percent
You can also compute your debtto- equity ratio by first subtracting total debt from total assets to get your total equity (or that amount which you own, and do not owe others), and then dividing your total debt by your total equity.