Page 122 - Finance for Non-Financial Managers

Siciliano07.qxd 3/20/2003 11:23 AM Page 103
Critical Performance Factors
1,667,000 – 591,000
Current Assets – Inventory
=
Current Liabilities
819,000
Typically lenders will look at the quick ratio rather = 1.3:1 103
than the current ratio if
they believe a company’s Quick ratio A measure-
inventory carries higher ment similar to current ratio,
than normal risk or is a except that the current
higher percentage of cur- assets calculation excludes inventory.
rent assets than they con- It’s thus a conservative version of the
current ratio.
sider wise. For the same
reason as the lenders, a
company should keep an eye on this ratio if it carries large
inventories, because it increases the risk of loss. If the current
ratio should typically be 2:1 or better, the quick ratio might need
only to be 1.3:1 or better. Since it will become cash more readily,
less of a safety margin is required for prudent management.
Days Sales Outstanding (DSO)
We’ve emphasized prompt collection of accounts receivable
numerous times in this book, not because we enjoy being
redundant but because it is so vital to so many aspects of a
successful business. So it’s not too surprising that one of the
key measures of liquidity would deal squarely with that issue.
Days sales outstanding (DSO) is the calculation of the number
of days of average sales yet uncollected in accounts receivable.
The arithmetic looks like this, again using Wonder Widget’s
balance sheet on Figure 3-1 and its income statement in Figure
4-1:
Monthly Revenue Accounts Receivable 940,000
= = = 43 Days
30 Average Revenue per Day 21,667
This metric tells you how closely the company is coming to
adhering to the collection terms printed on its invoices. Ideally,
a company will sell its products or services with 30-day terms
and customers will pay them 30 days later, so the DSO would
consistently be 30 days. Most companies offer 30-day credit
terms, yet the average DSO for companies across the country