5 Key Financial Ratios for Your Construction Business

A working capital ratio is an equation that expands on your knowledge of your working capital. When you know how to calculate it, and what to do to improve it, you can take steps to enhance your business’s liquidity. Money coming into your business increases your company’s working capital. Accounts receivable are the funds you expect to receive from customers.

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To answer this, let’s look at what the terms cash flow, free cash flow, and working capital mean. If you have excess or idle funds, you’ll know to start utilizing them more effectively. This can mean expanding the business, growing your team,  or investing in more stock. This helps you remain competitive in the marketplace while also preserving your ability to take advantage of potential opportunities that may arise in the future. Let’s dig into what working capital is, how it can be calculated, and why it’s important. Current assets include cash and other assets that can convert to cash within a year.

Current liabilities include short-term debts, accounts payable, and other short-term financial obligations. Maintaining a balanced working capital ratio is essential for the company’s financial health and operational efficiency. This metric not only reflects liquidity but also indicates the ability to manage short-term obligations. Ideally, a working capital ratio between 1.5 and 2 can help avoid liquidity issues and improve financial stability. The working capital ratio is essential for evaluating a company’s financial health and ability to fulfil its short-term obligations.

• It determines the business’s ability to pay off current liabilities with available current assets.
• Since this is less than 1.0, Matt doesn’t have enough assets he can quickly convert to cash to cover his current liabilities.
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• Working Capital is determined by subtracting Current Liabilities from Current Assets.

Negative working capital occurs when a company’s current liabilities exceed its current assets. In simpler terms, short-term debts (accounts payable, upcoming bills) are higher than readily available resources (cash, inventory, receivables). This can lead to worries regarding meeting payroll, paying debt, and may signal serious financial trouble. A negative working capital can be a sign of a decrease in revenue, mismanagement of inventory, or payments not being collected timely. The current ratio is a key indicator of your business’s ability to meet its short-term financial obligations.

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Regardless of industry, chances are you have some seasonal fluctuations in revenue. One of the most important aspects of procurement is understanding and utilizing working capital in the best way possible to ensure you are making the most of your resources. Let us calculate and conduct a working capital ratio analysisfor Colgate from the images above.

In other words, it measures the health of your company’s short term finances. It’s meant to indicate how capable a company is of meeting its current financial obligations and is a measure of a company’s general financial solvency. Companies and investors look at current assets and current liabilities in determining working capital, also known as net working capital.

What does a High Working Capital Turnover Ratio mean?

A low ratio suggests liquidity issues, potentially signalling that the company may face difficulties meeting financial obligations without external assistance. Monitoring this ratio allows businesses to take pre-emptive actions if liquidity concerns arise, ensuring smooth operational flow and financial stability. The working capital ratio is a key indicator in evaluating a company’s ability to meet its short-term funding obligations.

The ratio serves as an indicator of whether management is effectively converting working capital into sales. In practical terms, a current or short-term asset is one that can be converted into cash within 12 months, such as inventories or accounts receivable. Conversely, a current liability is an obligation that will come due within 12 months, such as accounts payable or a line of credit from the bank. These assets and obligations change on an ongoing basis and should be understood as a reflection of the company’s habits rather than a portrait of its potential long-term viability. Also a liquidity ratio, the working capital turnover ratio is found by dividing construction sales by your working capital. Because working capital is current assets minus current liabilities, this ratio reflects how much company value is freed up for construction projects.

In other words, there is more short-term debt than there are short-term assets on your balance sheet, and you’re probably worrying about meeting your payroll each month. Efficient working capital management ensures that a company can meet its short-term debt obligations and operational expenses. A firm with insufficient working capital might struggle to pay its creditors, leading to financial solvency issues or even bankruptcy. Liquidity ratios determine a company’s ability to pay off short-term debts using available assets. In the event that all short-term liabilities suddenly became due, liquidity ratios provide a glimpse as to whether your construction company would be able to cover those debts. In the case of working capital ratio, assets are typically defined as cash, inventory, accounts receivable, and short-term investments.

You can’t liquidate your inventory whenever you want – unless you’re willing to sell at a huge discount – so you shouldn’t rely on your inventory to cover short-term financial obligations. Your inventory, the items you intend to sell in the next year or less, are current assets. Of course, if you run a service-oriented business, this may what is a good working capital ratio not be a factor. Enhance your screening of customers to determine who is a good candidate for a credit line.

By understanding how to improve this ratio, you can free up more funds for potential growth and investment opportunities. This can be achieved through strategies such as reducing unnecessary expenses, optimizing inventory management and improving accounts receivable collections. By focusing on improving your working capital ratio, you can strengthen your financial position and create room for future business expansion. ‘Assets’ represent the resources a company owns and can quickly convert into cash, such as inventory, cash in hand, and accounts receivable.