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Many believe increased sales can solve any business problem. Often, they are correct. However, sales must be built upon sound
policies concerning other current assets and should be supported by sufficient working capital.
There are two types of working capital: gross working capital, which is all current assets, and net working capital, which is current
assets less current liabilities.
If you find that you have inadequate working capital, you can correct it by lowering sales or by increasing current assets through
either internal savings (retained earnings) or external savings (sale of stock). Following are ratios you can use to evaluate
your business's net working capital.
Use "Current Ratio" in the section on
"Liquidity Ratios".
This ratio is particularly valuable in determining your business's ability to meet current liabilities.
| Net Sales | = Working Capital Turnover Ratio |
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| Net Working Capital |
This ratio helps you ascertain whether your business is top-heavy in fixed or slow assets, and complements Net Sales to Tangible Net Worth
(see "Income Ratios"). A high ratio could signal overtrading.
Note: A high ratio may also indicate that your business requires additional funds to support its financial structure,
top-heavy with fixed investments.
| Current Liabilities | = Current Debt to Net Worth Ratio |
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| Tangible Net Worth |
Your business should not have debt that exceeds your invested capital. This ratio measures the proportion of funds that current
creditors contribute to your operations.
Note: For small businesses a ratio of 60 percent or above usually spells trouble. Larger firms should start to
worry at about 75 percent.
| Long-Term Debt | = Funded Debt to Net Working Capital Ratio |
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| Net Working Capital |
Funded debt (long-term liabilities) = all obligations due more than one year from the balance sheet date.
Note: Long-term liabilities should not exceed net working capital.
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