The current ratio measures the degree to which a contractor has the resources to cover financial obligations. This ratio is computed by dividing current assets (e.g., cash, marketable securities) divided by current liabilities (e.g., accounts payable, debt obligations due within one year). The ratio measures the number of times current assets can be used to satisfy current liabilities. Generally, a current ratio of at least 1.20 should be maintained, however, a goal of 1.5 or greater should be targeted to provide a cushion needed to weather more than just routine seasonal lulls.

When calculating the current ratio and working capital turnover, third parties will take a close look at the quality of the assets that are included in the calculation. For example, prepaid expenses are generally excluded from current assets, as they represent future expenses. Related party receivables (e.g., loans to owners or amounts due from another related entity) are likewise tossed, as the underlying assumption is that balances from such related parties will not be collected within one year.

Working capital turnover assesses the relationship between the funds used to support business operations and the revenue that it helps generate. This ratio equals revenue divided by working capital (i.e., assets minus current liabilities). It measures how working capital is utilized to generate profits in the company. This ratio will vary depending on the type, size, & nature of a contractor. Too high of a ratio increases sensitivity to cash flow interruptions and the contractor may not have adequate working capital to finance their projects and take them to completion.

Equity turnover ratio is calculated by dividing total revenue by Stockholders’ Equity. It measures how the stockholders’ investment is applied in the company activities. Too high of a ratio may indicate that the company is overextended with too little investment.

Banks and sureties may also look at the debt-to-equity ratio (total liabilities divided by total equity) to measure the extent to which outside money supports the business, also known as leverage. Higher ratios indicate that owners are relying more on their creditors to support the business rather than their own equity investment.

When hard work, diligence, and strong community ties lands a contractor in a position to secure a major project, it may be tempting to forego good financial judgment for the sake of taking advantage of a growth opportunity that may or may not be readily available in the future. Unfortunately, such gambles come with high risk. Unforeseen labor or material shortages, slow receipt of payment, withdrawal of credit, bad weather, and a number of other factors could turn an otherwise solid business into a house of cards. It’s a heavy price to pay for a shot at leapfrogging the steady growth curve.