How it’s Calculated
Growth Capacity calculation:
$ of Net Profit – ($ of Current assets – $ of Current liabilities)
= ______________________________________ x 100
How it’s Used
This ratio shows whether the business is capable of easily funding a higher turnover base. A positive result for this calculation indicates that the business should be able to fund its growth from additional profits; a negative result suggests that the business might experience liquidity problems if it grows.
So your result is negative, what can you do?
First, increase the ‘profit’ side of the equation:
- Promote more of your high-margin products or services – this can flow through into a higher net profit margin;
- Make your ‘production’ or ‘service’ processes as efficient as possible – this saves both overheads and labour;
- Focus on cost control through the entire business – what you use; how much you pay for it; how much you waste, and so on.
- See if you can reduce the owners’ drawings (whether they take the form of salary, or dividends or drawings, the end-result is still the same) – this keeps more of the profit in the business.
Second, reduce the amount of money tied up in the business:
- Reduce stock levels, if this can be done without losing sales;
- If your business has ‘work-in-progress’, re-design your work methods or policies so that jobs are completed more quickly, or negotiate staged billing of your customers at key stages during the ‘production’ process;
- Clearly outline your trading terms to customers, and make sure that someone in your business follows-up the slow-payers regularly – bill promptly, and ask for the money!
- Have enough cash to cover the foreseeable needs, then use the balance to reduce interest-bearing debt;
- Stretch creditors as far as possible within their trading terms.
The one constraint is to keep a sensible ‘current ratio’ while all this is happening: long-standing rules of thumb talk about current assets being around 1.5 to 2 times current liabilities, in order to be commercially sound. Retailers can get away with slightly lower levels, due to the high cash component in their sales.
Learn more about how Accountants and Business Advisors use the Benchmark Suite to add value for their clients.