Pest Control Industry Cost Study

Liquidity Ratios :

Liquidity is a measure of the quality and adequacy of current assets to meet current obligations as they come due. In other words, can a firm quickly convert its assets to cash without a loss in value in order to meet its immediate and short-term obligations?

For firms that can readily and accurately predict their cash inflows (recurring revenue model), focusing on liquidity is not nearly as critical as it is for firms that make their money by completing large projects that can have wide fluctuations in demand and revenue streams.

These ratios provide a level of comfort to lenders in the case of liquidation as well as allowing management to limit surprises when it comes to cash flow planning.

Many of the liquidity ratios are well documented as to typical averages in finance books and literature. However, may we suggest that you look at these numbers with a more critical eye and compare them with your overall strategy? A high growth firm may not be as liquid as a more mature firm. The banks may notice this as a higher credit risk. But the owner, if he/ she is experienced understands that this higher risk allows him/her to grow quicker. We are not in any way suggesting that a firm grow so fast that it has little liquidity. What we are suggesting is that you look at the numbers with a critical eye and understand how they fit into your full strategy. In terms of growth the owner or manager must operate in a comfortable manner and liquidity must be considered.

It should also be noted that the numbers reported in the survey are at calendar year end. From an operational and balance sheet prospective, many participants in the survey are in cold weather states which can have a profound effect on the ending balances thereby skewing some of the ratios negatively due to the time of measurement.

Current Ratio

One of the first ratios a lender looks at when examining a company for credit purposes. The Current Ratio gives an indication of a firm’s ability to meet its current obligations.  A ratio of 2:1 is preferred. The current ratio includes inventory as a current asset.

Quick Ratio

This ratio shows if there is sufficient cash or cash equivalents to immediately pay bills. The weakness with the quick ratio is it assumes accounts receivable are immediately collectible. Nevertheless, most lenders look at the Quick ratio for prospective. The Quick ratio does not include inventory.

Acid Test

This ratio asks us that if the business were stopped immediately would there be enough cash to pay the bills? A positive acid test would be 1:1 or above.

Times Interest Earned Ratio or the Interest Coverage Ratio

Measures a firm’s ability to pay the interest on outstanding debt. Most banks have covenants in their loan documents requiring borrowers to maintain at least a 1.25 ratio.

Liquidity                                                                                            Formula

Current Ratio                                                                                    CA / CL

Quick Ratio                                                                                       (Cash + A/R)  / CL

Acid Test                                                                                           Cash / CL

Times Interest Earned Ratio or Interest Coverage Ratio                  EBITDA / Interest Exp.

Where:

CA = Current Assets

CL = Current Liabilities

A/R = Accounts Receivable

EBITDA = Earnings Before Interest Taxes Depreciation and Amortization

Liquidity Mean Median
Current Ratio 1.79 1.87
Quick Ratio 1.57 1.69
Acid Test 0.79 0.84
Times Interest Earned ratio * 12.17 11.42

* Interest Expense – Usually shown below Net Income from Operations was on average 1.1 % of Revenue

Liquidity Ratios

Acid Test 1%
Quick Ratio 1.8%
Current Ratio 1.8%
Times Interest Earned Ratio 12%

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