BUST­ING THE JAR­GON

Finweek English Edition - - COVER STORY -

At we are al­ways look­ing to ed­u­cate our read­ers about dif­fer­ent ra­tios and meth­ods of eval­u­at­ing com­pa­nies. In the McGre­gorBFA Weighted Com­pos­ite In­dex, we talk about gear­ing and the cur­rent ra­tio. Here is what we mean: Gear­ing ex­plains how a com­pany fi­nances its op­er­a­tions. This could be ei­ther through out­side lenders, bank fa­cil­i­ties or through share­hold­ers agree­ments. The ideal com­pany should be ungeared, but if it is geared, it should be geared ef­fec- tively us­ing the fa­cil­i­ties that are avail­able to it. This ra­tio is used to give in­ter­ested par­ties an idea of the com­pany’s abil­ity to pay back its short-term li­a­bil­i­ties, with its short-term or cur­rent as­sets in­clud­ing cash re­sources, in­ven­tory or debtors.

The higher the cur­rent ra­tio, the more ca­pa­ble the com­pany is of meet­ing its obli­ga­tions. A ra­tio un­der 1 sug­gests that the com­pany would be un­able to pay off its debts if they came due at that point. While this shows the com­pany is not in good fi­nan­cial health, it does not nec­es­sar­ily mean that it will go bank­rupt.

The cur­rent ra­tio can give a sense of the ef­fi­ciency of a com­pany’s op­er­at­ing cy­cle or its abil­ity to turn its prod­uct into cash. Com­pa­nies that have trou­ble get­ting paid on their re­ceiv­ables or have a long in­ven­tory turnover can run into liq­uid­ity prob­lems be­cause they are un­able to ful­fil their obli­ga­tions.

One should try and find com­pa­nies in the same in­dus­try to com­pare cur­rent ra­tios. For in­stance, a man­u­fac­tur­ing busi­ness will not be di­rectly com­pa­ra­ble to a re­tail busi­ness.

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