A while back, we did a piece on how the bank's establish the credit worthiness of a small business loan or the "Five C's of Credit".
Following up this week we'll go over Capital.
Capital is the built up reserves a business holds. Capital can be liquid or not.
Many banks will attempt to evaluate your liquid capital; your current assets (cash, accounts receivable, inventory) less your current liabilities (accounts payable, accrued expenses, short term debt obligations).
Depending on the business, a well capitalized company will have a current ratio (current assets divided by current liabilities) of at least 2 to 1. Meaning that the company has $2 in current assets for every dollar in current liabilities.
A prudent banker becomes concerned if this ration deteriorates over time.
For instance, if a company's current ratio is less than 1.0 to 1, it indicates that the company does not have the resources to pay it's current debt obligation. In addition, it could indicate that the company has a good deal of uncollectable receivables and/or obsolete inventory that cannot be sold.
Review your current ratios over time and notice your company's trends. it may tip you off as to why your feeling a liquidity pinch.
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