There are a lot of financial ratios. You don't need all of them. You need the ones that answer the questions you're actually asking.
Here are the three I look at first — every time, for every business.
Quick Reference
| Ratio | Formula | 🟢 Healthy | 🟡 Watch It | 🔴 Problem |
|---|---|---|---|---|
| Working Capital | Current Assets − Current Liabilities | 30–60 days of expenses or more | Thin relative to revenue | Negative |
| Current Ratio | Current Assets ÷ Current Liabilities | Above 1.50 | 1.20–1.50 | Below 1.20 |
| Debt-to-Worth | Total Liabilities ÷ Total Equity | Below 2:1 | 2:1–3:1 | Above 3:1 |
1. Working Capital (Dollar Amount)
Working capital isn't a ratio. It's a dollar amount, and it's more important than any ratio on this list.
Working Capital = Current Assets − Current Liabilities
Current assets: cash, accounts receivable, inventory — things that convert to cash within 12 months. Current liabilities: accounts payable, current loan payments, accrued payroll — obligations due within 12 months.
The difference is your cushion. It's what keeps the business running through the gaps: the customer who pays in 60 days while you owe vendors in 30, the slow season, the unexpected repair.
The mistake most owners make: They look at their checking account balance and call that their working capital. It isn't. Working capital includes everything coming in and everything going out over the next year. A business can have $200,000 in the bank and negative working capital if there are enough near-term liabilities the owner hasn't thought about.
2. Current Ratio (The Multiple)
If working capital is the dollar amount, the current ratio is how lenders look at the same picture.
Current Ratio = Current Assets ÷ Current Liabilities
| Result | What It Means |
|---|---|
| Above 2.0 | Strong — two dollars of short-term assets for every dollar owed |
| 1.50–2.0 | Healthy — comfortable cushion |
| 1.20–1.50 | Acceptable — most lenders will work with this |
| Below 1.20 | Raises questions — lenders get cautious |
| Below 1.0 | Short-term liabilities exceed short-term assets — usually a dealbreaker |
The ratio and the dollar amount both matter. A current ratio of 2.0 sounds healthy — but if your current assets are $40,000 and liabilities are $20,000, you have $20,000 of working capital. That may be fine for a small business, or dangerously thin depending on your monthly burn rate. Always look at both.
Real example: An HVAC contractor with $7M in revenue has a current ratio of 2.07 — looks fine. But actual working capital is $182,000 — less than 10 days of revenue. One big customer paying late and the company is calling the bank for a line extension. The ratio was misleading without the scale.
3. Debt-to-Worth (Leverage)
This ratio tells you how leveraged your business is — how much of the operation is funded by debt versus equity the owners have actually built.
Debt-to-Worth = Total Liabilities ÷ Total Equity
| Ratio | What Lenders Think |
|---|---|
| Below 1:1 | Excellent — you own more than you owe |
| 1:1–2:1 | Strong — manageable leverage |
| 2:1–3:1 | Acceptable but watching closely |
| 3:1–4:1 | High — limits additional borrowing |
| Above 4:1 | Very high — additional debt is difficult; almost no margin for error |
What high leverage actually costs you:
- Options disappear. A highly leveraged business has limited ability to take on new debt — for equipment, growth, or a line of credit during a slow stretch.
- Bad years hurt more. A business with strong equity can absorb a $100,000 loss. A 4:1 leveraged business may not survive one.
- It tells a story. Equity builds through retained earnings — profit that wasn't distributed. High leverage often signals inconsistent profitability or owners drawing more than the business earned.
Reading All Three Together
No single ratio tells the whole story. Here's how the picture looks at three different levels of health:
| Working Capital | Current Ratio | Debt-to-Worth | What It Means | |
|---|---|---|---|---|
| 🟢 Healthy | Strong in dollars | Above 1.5 | Below 2:1 | Gets good loan terms. Can absorb a bad quarter. Room to grow. |
| 🟡 Thin | Adequate | ~1.20 | Near 3:1 | Functioning, but not much margin. Lenders will look closely. One slow quarter tightens things fast. |
| 🔴 Stressed | Low or negative | Below 1.0 | Above 4:1 | May still be profitable on paper. But the balance sheet tells a different story — and lenders read it. |
The goal isn't to obsess over these numbers weekly. It's to know them — actually know them — so when an opportunity comes up, or you need financing, or something goes sideways, you understand exactly where you stand before anyone else has to tell you.
Next: what your balance sheet is telling you that your P&L never will — and why profitable businesses run out of cash.
jrbohlke.com • The Analysis