CREDIT CORNER

 

 

ARE YOUR CUSTOMERS PAYING THEIR BILLS WITH

YOUR MONEY?

 

 

 

 BAD DEBT LOSS                                   SALES TO LOSS RATIO

	2%	4%	6%	8%	10%
$1,000	$50,000	$25,000	$16,667	$12,500	$10,000
$2,000	$100,000	$50,000	$33,333	$25,000	$20,000
$3,000	$150,000	$75,000	$50,000	$37,500	$30,000

 

If your profit before taxes is 5%, a credit loss (bad credit) of $500 means the loss of the entire profit on sales of $10,000 to others.  Or, putting it another way using the same formula – a loss of $500 (bad debt) requires $10,000 of additional profitable sales to offset the bad debt loss.

 

 

BASIC LIQUIDITY RATIOS

 

CURRENT RATIO

 

     TOTAL CURRENT ASSETS__

TOTAL CURRENT LIABILITIES

 

The current ratio is the granddaddy of financial ratios and is a basic measure of liquidity.  Companies need more current assets than current liabilities if they are to pay all debts on time.  A 2 to 1 ratio is the Standard of Excellence.  Less than 1 to 1, increases your risk substantially.

 

QUICK RATIO  (ACID TEST)

 

CURRENT ASSETS – INVENTORY AND PREAPIDS

CURRENT LIABILITIES

 

The quick ratio is a test of liquidity that supplements the current ratio.  In this case, inventory and other less liquid correct assets are left out, giving a more immediate indicator of ability to pay.  The Standard of Excellence is 1 to 1.  A quick ratio of less than .25 to 1 would be worrisome.

 

 

AVERAGE COLLECTION PERIOD / DAYS SALES OUTSTANDING

 

ACCOUNTS RECEIVABLE * NUMBER OF DAYS IN MONTH

NET SALES FOR THAT MONTH

 

This ratio is probably the signal best indicator of the quality of account receivable.  It shows the average number of days to collect a receivable.  If the ratio starts creeping up, it may be a sign that bad debts are accumulating.  Recommended 1.5 x net terms.  For example, it terms are 2-10, N-30, the Standard of Excellence would be 45 days or less, which is about the national average.  Any 10 days greater than the standard, should receive some management attention.