A current ratio larger than 2:1 indicates that your company has enough assets to convert into cash and pay its bills. Note that a current ratio between 1.8:1 and 2:1 is normal for distributors. The ratio is generally this high because gross margins are high and inventory is sold fairly rapidly. Also, since suppliers must be paid quickly, distributors need liquidity to insure that they pay their suppliers on time.
If your current ratio is this large, you should: (1) make sure you have included all your liabilities; (2) make sure you have not included any long-term assets (property, plant, equipment, and so forth) in your current assets; (3) satisfy yourself that your inventory is still worth the value shown in the general ledger -- that it is current, salable, and can be sold for at least as much as its value on your books; and (4) make sure that all of your receivables are truly collectible.
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A current ratio over 2:1 generally indicates that your business is healthy. It may, however, indicate that you are building up assets too quickly, especially if the current ratio has increased recently. For example, your accounts receivable may be growing because your bill collection is slowing down.
Inventories may be up because you have added goods to inventory in anticipation of sales that might not materialize. You should review the value of your inventories carefully and satisfy yourself that all of your merchandise is current, salable, and valued at a price that you could sell it for.
Finally, you should review your cash balances and satisfy yourself that your cash reserves are being invested effectively. You might consider opening a money market account or having your bank put some of your excess cash in short-term, high grade investments.
There are several ways to increase your current ratio. Raising prices or lowering product costs, or both, will increase your profitability and your current ratio at the same time. Converting short-term debt into long-term debt will also improve your current ratio.
