Current Ratio: Strategies for Improvement
1. Increase Current Assets
- Retain Profits: Instead of distributing all profits as dividends, retain some to boost cash reserves or invest in other current assets.
- Improve Accounts Receivable Collection: Speed up the collection of payments from customers to increase cash flow.
A retail business could retain profits to increase its cash reserves, improving its current ratio.
TipConsider offering discounts for early payments or implementing stricter credit policies.
2. Reduce Current Liabilities
- Pay Off Short-Term Debts: Use available cash to reduce liabilities, such as overdrafts or short-term loans.
- Negotiate Better Credit Terms: Work with suppliers to extend payment deadlines, reducing the immediate burden of liabilities.
Be cautious not to deplete cash reserves entirely, as this could create liquidity issues.
ExampleA manufacturing firm could negotiate 60-day payment terms instead of 30 days, easing short-term cash flow pressures.
3. Optimize Inventory Management
- Reduce Overstocking: Excess inventory ties up cash that could be used to pay liabilities.
- Implementing just-in-time (JIT) inventory systems can help.
- Convert Inventory to Cash: Focus on selling slow-moving or obsolete inventory to free up cash.
A clothing retailer could use data analytics to forecast demand more accurately, reducing excess stock.
TipConsider running promotions or discounts to accelerate sales of stagnant inventory.
