How Can I Grow My Company’s Credit Score?
Checking your business credit worthiness is not for the meek of heart and can be done without ever leaving the office, calling your bank or logging on to the Internet. As a Gwinnett CPA for decades we have helped hundreds of Atlanta and Gwinnett business owners stay abreast of important issues that will affect the financial viability of their business. All you need to do is to print out your internal financials and utilize a few basic mathematical calculations and you are well on your way.
Entrepreneurs often feel they need outside professional advisors and CPA’s, which frequently they do for many of the more complex tax and management issues they face. However, there are a few key internal management statistics each and every owner should be well apprised of and able to put their hands on at a moments notice. Ownership of these statistics will set you well ahead of your peers and give you key operating information which when used properly will grant you a competitive edge in the marketplace.
These statistics are for those who are familiar with most of the basic tenets of a balance sheet and profit and loss. If you are not, these principles and guidance are easily learned. As you review these calculations/ratios, stop and apply them and see how your business compares.
A/R (Accounts Receivable) Turnover
This ratio calculates how often your account receivables turn over/are paid by your clients. Generally, you would want your A/R to turn over approximately twelve times a year, which would mean your average monthly billings are paid within thirty days. This is calculated by dividing annual sales by A/R equals your turnover ratio. For example:
Annual Sales or $720* = A Turnover
Accounts Receivables $60 Ratio of 12*Monthly sales of $60K times twelve months
Care should be taken in reviewing/relying upon this calculation to also evaluate the aging of your receivables and to review in detail all substantive account balances over thirty days for any potential collection issues/corrective action required.
Days in Receivable (A/R)
This calculation reveals to its user as to how long receivables are unpaid/what the billing to payment cycle is. A lower calculation result will signify that receivables are being collected sooner than later. As with any business, “cash is king” as you cannot be fiscally responsible without cash in the bank. Days in receivables are calculated by dividing your A/R by your last months/average monthly sales.
Open A/R Balance or $90K = 1.5×30 days/month = 45 days in
Last Month/Avg. Monthly Sales $60K in receivables
Days in A/R is one calculation you will want to be as low as possible and care should be taken to evaluate it in light of:
- Your industry, its norms and trends
- The credit terms you extend to your clients
- Present economic conditions locally, nationally and internationally
Inventory Turnover
If you are more aware of how efficiently/quickly your inventory is turning/selling you will be better apt to ensure that you do not either overstock or run out of your faster moving items. This calculation can be applied to the total inventory, a particular class or segment of your business and even to individual items to discern the nuances of your inventories and sales ability. Also, this process can be used to weed out less profitable/marketable lines/items of inventory. Calculation of your inventory turnover is done by dividing your annual cost of goods sold/purchases by your present inventory, illustrated by the below:
Annual Purchases or $480K = Inventory Turnover of
Present Inventory at Cost $40K 12 times annually
Days in Inventory
A keen knowledge and awareness of how much inventory you have on hand and its marketability is one of the primary indicators of future success/profitability. This indicator will reveal to you if your inventory levels are too high or too low. Your industry and suppliers will dictate much of your desired levels so you will want to be sure to gain an adequate understanding of your particular nuances. However, a general rule of thumb would be to have approximately forty-five days in inventory. This can be determined by dividing your total inventory by your past months/average monthly sales at costs and then by multiplying it against the number of days in a month, for example:
Inventory or $80K x 30 days in a month =
Months of Purchases at Cost $40K 60 days in inventory
Current Ratio
The current ratio is calculated by taking the total of all of your total current assets and dividing it by the sum of your total current liabilities. For a typical rule of thumb it is suggested that this ratio should be two or better, as this indicator will foretell your firm’s ability to meet its current obligations as they become due. To illustrate how to calculate this ratio:
Current Assets or $400K = 2.0 Current Ratio
Current Liabilities $200K
In conjunction with this calculation it would be prudent to also perform the earlier stated ratios/turnovers as they will assist in determining the integrity and soundness of the accounts receivable and inventory balances included in the current assets and liabilities totals.
Acid Ratio
The acid test ratio is a key-determining factor in helping to evaluate a firm’s ability to meet its immediate cash needs. This calculation is preformed by taking all of your quick assets (cash balances plus all items which can quickly be converted to cash) and dividing it by the firms total liabilities, illustrated by the below:
Quick Assets or $300K = 1.5 Acid Ratio
Current Liabilities $200K
The acid ratio will most always be less than the current ratio and it reveals a firm’s ability to meet its immediate cash needs.
We work with clients each and every day in meaningful and insightful ways to look beyond the numbers to provide significantly meaningful management information.