Definition of Working Capital to Monthly Expense Ratio

Save

Financial ratios express relationships between financial statement items for nonprofit and for-profit organizations. Nonprofit organizations, such as hospitals and medical centers, use the working capital to monthly expense ratio along with other financial indicators to assess current financial conditions. This ratio is equal to the available working capital divided by the average monthly expenses, expressed in months. It is also known as the months in working capital ratio.

Facts

According to an Arizona Association of Community Health Centers presentation document, the data for the working capital to monthly expense ratio comes from the audited financial statements. The working capital is equal to the current assets minus the current liabilities. A hospital's current assets could include cash assets, grant receivables, patient receivables and prepaid expenses. The current liabilities could include accounts payable, short-term loans and accrued expenses. Receivables refer to amounts that an organization reasonably expects to collect in cash in due course. The average monthly expenses are equal to the total expenses in a period divided by the number of months.

For example, if the current assets are $2 million at year-end, current liabilities are $1 million and the average monthly expenses are $500,000, then the working capital is $1 million ($2 million minus $1 million) and the working capital to monthly expense ratio is 2 months ($1 million divided by $500,000 per month).

Significance

A high ratio means that an organization has sufficient liquid reserves to cover its monthly expenses, while a low ratio could signal cash flow problems in the near term. A steady or rising ratio trend is a positive indication, while a declining trend is a negative indication. A new business should have a certain number of months of working capital in reserve before the sales proceeds are sufficient to cover its operating expenses. Consultant and author Richard Parker wrote on the BizQuest website that small businesses should aim for a three-month working capital cushion. According to the Hoffman Consulting Group, a commercial loan consulting company, lenders prefer to see three to six months of working capital before approving loans. A high ratio is an indication of more conservative business management and a healthy cash flow business.

Strategies

Strategies to increase the ratio include increasing working capital and reducing monthly expenditures. Organizations can increase working capital by increasing current assets, decreasing current liabilities or doing both. Monthly expense reduction measures could include better scheduling, negotiating reduced terms with suppliers for bulk purchases and continually looking for ways to save on overhead expenses, such as travel and administration.

Considerations: Related Financial Measures

For hospitals, a related financial measure is the total cost per patient ratio, which is equal to the total accrued costs -- before donations but after allocating overhead expenses -- divided by the total number of patients. Reducing cost per patient should improve the working capital to monthly expenses ratio. (See Resource 1)

Related Searches

References

Promoted By Zergnet

Comments

You May Also Like

Related Searches

Check It Out

Are You Really Getting A Deal From Discount Stores?

M
Is DIY in your DNA? Become part of our maker community.
Submit Your Work!