A working capital ratio for the company can be extremely high in the sense that too high ratio is generally regarded as a sign of operational inefficiency. Normally, an extremely high ratio can mean a firm is not making maximum use of the huge amount of assets for reinvestment of available capital to expand and grow its business. In the fundamental analysis of a firm, working capital is a valuable concept. Examining the working capital position of a company gives a clear indication of how the company is financially sound and how effectively is being operated (Bhalla, 2017). The ratio is regarded as the main metric of liquidity and is always used together with the current ratio to assess the ability of the firm to meet its short-term expenses.
The working capital ratio is computed by dividing the current assets by the company’s current liabilities. Current assets refer to the assets which a company anticipates to be converted into liquid or cash in one year. This involves items such as cash equivalents, account receivables, and inventory. Current liabilities, on the other hand, include payable dividends, income taxes, leases, and account payables (Byrne, 2016). Analysis of working capital incorporates main elements of the business operations including account payables, account receivables, and inventory. How the company manages, each of these components can be reflected in the working capital ratio of the company. Inefficient or efficient handling of the business operations has a direct impact on the working capital position of the company.
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A working capital ratio of say 1.0 implies that the financial assets of the company readily match the current company liabilities. The ratio of 1.0 means the company can meet its short-term expenses adequately. A working capital higher than 1.0 means that the firm has more working capital left over to meets its short-term obligations. An excess working capital offers certain cash cushion and can be invested back in the growth of the company. Any ratio below 1.0 is not favorable, as it implies the current assets of the company are not enough to cover the short-term obligations.
A working capital ratio between 2 and 1.3 is regarded as a positive indication of sufficient liquidity as well as favorable financial health. Nevertheless, the ratio greater than 2.0 is not favorable for the company. An extreme high ratio indicates the firm is letting excess assets and cash to sit idle than investing its capital actively in the expansion of the company business. This implies lost business opportunities and poor financial management.
There are several ways Trevose Fitness Center (TFC) can optimize its cash budgets. If the customers are not paying in cash, it will be important for TFC to carry out the credit check, particularly before signing up. In case the client will have poor credit, then it is good to assume that TFC will not get payments on time. As severely as TFC want to generate more revenue, paying late will hurt the cash flow of TFC. If TFC wants to offer its services despite at the questionable credit, then it will be important to offer the services at high-interest rates. TFC should make use of an electronic payment system. TFC will wait until the morning to make a payment when the bill is due. This buying of time will enhance the cash flow of TFC. It is advisable for TFC to make use of business credit card since some credit card offers a grace period of 21 days, which can increase the cash flow.
References
Bhalla, V. K. (2017). Working capital management . S. Chand Publishing.
Byrne, B. A. (2016). Working capital management.
