Business owners and financial managers know the importance of cash flow and working capital as generated by their accounts receivable and inventory accounts. What is the ultimate effect of a lack of cash flow and working capital – we know the answer – it is a business failure.

Business owners can utilize a financial analysis technique that finance textbooks call the ‘DOOMSDAY RATIO ‘. What is that ratio and what is its significance?

The Doomsday ratio is calculated by the following easy formula:

Cash divided by Current Liabilities.

This is one of the most powerful and effective solvency ratios that a business owner can utilize. Business people might be aware of two other similar ratios, the current ratio and the quick ratio. The current ratio included the firm’s current assets, including accounts receivable and inventory. The Quick ratio did the same but excluded inventory.

The business owner can quickly see that the doomsday ratio focuses solely on Cash! We can call it a very demanding ratio because it focuses solely on the liquid gold within the company, cash! As liquid as your receivables and inventory are, they aren’t cash yet, and everyone knows the day to day business challenges of converting receivables and goods into a final cash customer payment.

Really the best way to look at the Doomsday ratio is to view it as an ongoing measure of the firms cash ‘buffer’. The bottom lien is that it will show the business owner what ‘cushion’ of cash the firm has. Business owners could even choose to monitor the ratio daily, as it could very well warn against impending shortages of working capital.

Many business owners know that it is also not productive to carry cash on hand, particularly in today’s low interest rate environment. So it makes common sense that the doomsday ratio may in fact be less than one, but at least we have a number that, on an ongoing basis, we can monitor.

Each business over time has a philosophy and business practice around how much cash is kept on hand. Naturally it’s also obvious, and important to know that if you reduce your operating line of credit with you cash you still have the full liquidity of your operating line, but you aren’t paying any interest to borrow. That’s a good strategy also.

Customers can also enhance their position by factoring or selling their accounts receivable, which would put them in a strong position to generate cash and maintain a positive Doomsday Ratio.

In summary, the analysis technique is a valuable took to monitor cash flow/working capital for any business.


7 Park Avenue Financial :

South Sheridan Executive Centre
2910 South Sheridan Way
Suite 301
Oakville, Ontario
L6J 7J8

Direct Line = 9053024171

Office = 905 829 2653
Email = greg@7parkavenuefinancial.com

http://www.7parkavenuefinancial.com

Business financing for Canadian Firms , specializing in working capital, cash flow, asset based financing , Equipment Leasing , franchise finance and Cdn. Tax Credit Finance . Founded 2004 – Completed in excess of 100 Million $ of financing for Canadian corporations .

‘ Canadian Business Financing With The Intelligent Use Of Experience ‘

ABOUT THE AUTHOR
Stan has had a successful career with some of the world’s largest and most successful corporations.
Prior to founding 7 Park Avenue Financial in 2004 his employers over the last 25 years were, ASHLAND OIL, ( 1977-1980) DIGITAL EQUIPMENT CORPORATION, ( 1980-1990) ) CABLE & WIRELESS PLC,( 1991 -1993) ) AND HEWLETT PACKARD ( 1994-2004 ) He is an expert in Canadian Business Financing.

Stan has over 40 years of business and finance executive experience. He has been recognized as a credit/financial executive for three of the largest technology companies in the world; Hewlett-Packard, Digital Equipment and Cable & Wireless. Stan has had in depth, hands on experience in assessing and evaluating thousands of companies that are seeking financing and expansion. He has been instrumental in helping many companies progress through every phase of financing, mergers & acquisitions, sales and marketing and human resources. Stan has worked with startups and public corporations and has many times established the financial wherewithal of organizations before approving millions of dollars of financing facilities and instruments on behalf of his employers.

Stan Prokop

Article Source: http://EzineArticles.com/expert/Stan_Prokop/432698

Article Source: http://EzineArticles.com/3715322
7 Park Avenue Financial
Canadian Business Financing