Current ratio

The current ratio is a financial ratio that shows the proportion of current assets to current liabilities. The current ratio is used as an indicator of a company's liquidity. In other words, a large amount of current assets in relationship to a small amount of current liabilities provides some assurance that the obligations coming due will be paid.

If a company's current assets amount to $600,000 and its current liabilities are $200,000 the current ratio is 3:1. If the current assets are $600,000 and the current liabilities are $500,000 the current ratio is 1.2:1. Obviously a larger current ratio is better than a smaller ratio. Some people feel that a current ratio that is less than 1:1 indicates insolvency.

It is wise to compare a company's current ratio to that of other companies in the same industry. You are also wise to look at the trend of the current ratio for a given company over time. Is the current ratio improving over time, or is it deteriorating?

The composition of the current assets is also an important factor. If the current assets are predominantly in cash, marketable securities, and collectible accounts receivable, that is more comforting than having the majority of the current assets in slow-moving inventory.

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Current Ratio

Current ratio is one of the most fundamental liquidity ratio. It measures the ability of a business to repay current liabilities with current assets.

Current assets are assets that are expected to be converted to cash within normal operating cycle, or one year. Examples of current assets include cash and cash equivalents, marketable securities, short-term investments, accounts receivable, short-term portion of notes receivable, inventories and short-term prepayments.

Current liabilities are obligations that require settlement within normal operating cycle or next 12 months. Examples of current liabilities include accounts payable, salaries and wages payable, current tax payable, sales tax payable, accrued expenses, etc.

Formula

Current ratio is calculated using the following formula:

Current Ratio =	Current Assets
	Current Liabilities

Companies are required by GAAP to classify assets and liabilities into current and non-current on their balance sheets. This simplifies calculation of current ratio for liquidity analysis. All we need to do is to obtain the current assets and current liabilities figure and divide the former by later.

Where a classified balance sheet (i.e. a balance sheet in to which there is a current and non-current categorization) is not available, we need to analyze the balance sheet line items to identify current assets and current liabilities. Assets and liabilities are listed in the descending order of liquidity, i.e. assets appearing at the top are more liquid than assets at the bottom of the balance sheet.

Analysis

Current ratio matches current assets with current liabilities and tells us whether the current assets are enough to settle current liabilities. A current ratio of 1 or more means that current assets are more than current liabilities and the company should not face any liquidity problem. A current ratio below 1 means that current liabilities are more than current assets, which may indicate liquidity problems. In general, higher current ratio is better.

A more meaningful liquidity analysis can be conducted by using current ratio in conjunction with other measures such as quick ratio (also called acid-test ratio), cash ratio, receivables turnover ratio, inventory turnover ratio and cash conversion cycle.

Current ratios should be analyzed in the context of relevant industry. Some industries for example retail, have very high current ratios. Others, for example service providers such as accounting firms, have relatively low current ratios because their business model is such that they do not have any significant current assets.

However, there is a limit to the extent to which higher current ratio is a blessing. An abnormally high value of current ratio may indicate existence of idle or underutilized resources in the company. This is because most of the current assets do not earn any return or earn a very low return as compared to long-term projects. A very high current ratio may hurt a company’s profitability and efficiency.

Example

Calculate and analyze current ratios for The Coca Cola Company (NYSE: KO) and PepsiCo. Inc. (NYSE: PEP) based on the information given below:

		2014	2013	2012
Coca Cola	Current assets	32,986	31,304	30,328
	Current liabilities	32,374	27,811	27,821
PepsiCo	Current assets	20,663	22,203	18,720
	Current liabilities	18,092	17,839	17,089

All amounts are in USD in million.

Solution

Current ratio for Coca Cola for 2014 =	32,986	= 1.02
	32,374

The following table shows current ratios for both companies for all three years:

	2014	2013	2012
Coca Cola	1.02	1.13	1.09
PepsiCo	1.14	1.24	1.10

We see that PepsiCo. has higher current ratios than Coca Cola in each of the three years which means that PepsiCo is in a better position to meet short-term liabilities with short-term assets. However, current ratios for Coca Cola too have stayed above 1 in all periods, which is not bad.

Both companies experienced improvement in liquidity moving from 2012 to 2013, however this trend reversed in 2014.

Written by Irfanullah Jan

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Related Topics

• Quick Ratio (Acid Test)
• Cash Ratio
• Balance Sheet
• Cash Conversion Cycle
• Financial Ratio Analysis

Current ratio

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Diseconomies of scale

Diseconomies of scale occurs when long run average costs start to rise with increased output.

Economies of scale occur up to Q1. After output Q1, long run average costs start to rise.

Dis-economies of scale can occur for the following reasons:

1. Poor communication in a large firm
2. Alienation: Working in a highly specialized assembly line can be very boring, if workers become de motivated. In a large firm there is an increased gap between top and bottom e.g. call centres
3. Lack of control: when there is a large number of workers it is easier to escape with not working very hard because it is more difficult for managers to notice shirking.

Overcoming diseconomies of scale

Firms may attempt to overcome diseconomies of scale by splitting up the firm into more manageable sections. For example, a large multinational may be split up into local geographical areas, with local managers facing incentives to maximise efficiency.

Minimum Efficient Scale

This is the minimum point of output necessary to achieve the lowest A.C. on the LRAC. In the above diagram, the MEC is at Q1.

• This has implications for the optimal number of firms in the industry
• If the MES was 10,000 cars a week and the total industry demand was 40,000. This would mean that the optimal number of firm would be 4, if there were more firms in the industry then average costs would be significantly higher.
• In a natural monopoly the optimal number of firms is one, therefore the MES would be equal to the total industry demand. E.g. Water or Electricity networks

The minimum efficient scale will be determined by factors such as:

• i) Degree of fixed costs
• ii) Scope for specialisation

Decreasing Returns to scale

Returns to scale relates to how a firms production is affected by increasing all the inputs.

Decreasing returns to scale implies that increasing the inputs by 50%, would increase the actual output by less than 50% (e.g. 40%)

Relationship with economies of scale

If a firm faces constant input costs, then decreasing returns to scale imply rising long run average costs and diesconomies of scale.

However, it is possible that if the firm gains purchasing economies then increasing the factor inputs by 50% may not actually increase costs by 50%. Therefore, it is possible to have decreasing returns to scale, but not necessarily diseconomies of scale. But, if we assume a constant input price, decreasing returns will cause diseconomies of scale.

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Diseconomies of scale

A business can become so large that its unit costs begin to rise. Expanding firms can experience diseconomies of scale. Causes include:

• Ineffective communication. Coordinating large numbers of staff becomes a challenge. Big businesses can develop many levels of hierarchy which slow down communication or even lead to miscommunication.
• Reduced motivation. Staff can feel remote and unappreciated in a large organisation. When staff productivity begins to fall, unit costs begin to rise.

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Diseconomies of scale

Diseconomies of scale occur when a business grows so large that the costs per unit increase. As output rises, it is not inevitable that unit costs will fall. Sometimes a business can get too big!

Diseconomies of scale occur for several reasons, but all as a result of the difficulties of managing a larger workforce.

Poor communication

As the business expands communicating between different departments and along the chain of command becomes more difficult. There are more layers in the hierarchy that can distort a message and wider spans of control for managers. This may result in workers having less clear instructions from management about what they are supposed to do when.

In addition, there may be more written forms of communication (e.g. newsletters, notice boards, e-mails) and less face-to-face meetings, which can result in less feedback and therefore less effective communication.

Lack of motivation

Workers can often feel more isolated and less appreciated in a larger business and so their loyalty and motivation may diminish. It is harder for managers to stay in day-to-day contact with workers and build up a good team environment and sense of belonging. This can lead to lower employee motivation with damaging consequences for output and quality. The main result of poor employee motivation is falling productivity levels and an increase in average labour costs per unit.

What can a business do about this? Possible solutions include:

Delegation of decision-making (empowerment)

Making jobs more interesting (job enrichment)

Splitting employees into teams (teamworking)

There is also a close link between communication and motivation (which the motivational theorist Elton Mayo recognized) and so as communication becomes harder, motivation will decline. This is particularly true as managers are less able to take a personal interest in the workers.

Loss of direction and co-ordination

It is harder to ensure that all workers are working for the same overall goal as the business grows. It is more difficult for managers to supervise their subordinates and check that everyone is working together effectively, as the spans of control have widened. A manager may be forced to delegate more tasks, which while often motivating for his subordinates, leaves the manager less in control.

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Diseconomies of scale

Diseconomies of scale

DEFINITION of 'External Diseconomies Of Scale'

External factors beyond the control of a company increases its total costs, as output in the rest of the industry increases. The increase in costs can be associated with market prices increasing for some or all of the factors of production.

BREAKING DOWN 'External Diseconomies Of Scale'

Factors of production are the inputs that firms use in order to produce output. The inputs include land, labor and capital. Some economists include entrepreneurship as well.

For example, assume there is a manufacturer of 'widgets' in a given city. If the average wage level increases across all other markets as a result to an increased demand for labor, then to entice workers to produce "widgets", the manufacturer must pay more in wages, which will raise the total costs.

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Diseconomies of scale

Diseconomies of scale is the point where a business no longer experiences decreasing costs per unit of output. Rather, after this point, costs per unit tend to increase.

Graphically, if output is on the X-axis, and average cost per unit is on the Y-axis, the economy of scale line curves downward from left to right. But as the line continues curving to the right, it reaches a point where it flattens and then begins to curve upward. The point where it starts curving upward represents the diseconomies of scale. 

A number of factors contribute to diseconomies of scale. 

For instance, if the manufacturing process involves multiple steps, there may be a volume level that creates a bottleneck for one process.  If, in the factory, process A is unlimited, but process B can only manage 50,000 units, then the company will experience diseconomies of scale above 50,000 units due to the added cost of acquiring more capacity for process B.

Shipping can also create diseconomies of scale.  For instance, a candle manufacturer sells candles to local merchants only. But if that candle manufacturer develops a website to increase production, then sells candles throughout the world, the added costs of shipping the candles may negate any cost savings resulting from increased output.

Finally, as a company grows, it has more communication and bureaucracy issues that interfere with efficiency.  If everything runs well, the concept of economies of scale works, but more output requires more people to run the company. 

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Setting Marketing Objectives

Make Your Objectives Relevant to Your Business

At AsOne, not only do we invest time upfront with our clients to scope out their vision and goals, we also work with them to ensure they are looking at the right marketing objectives for the precise nuances of their campaign.

It is so important that the objectives are relevant to your business and the marketing channels you are using.

For instance, objectives related to PPC will be very different to those related to SEO or content marketing and the time scales will also vary greatly. Where a PPC or Google Remarketing campaign might focus on optimising the cost per click while maximising the total number of clicks, a content marketing campaign might focus on the average page rank of specified keywords, or the total number of pages ranked in Google.

Be S.M.A.R.T about Objective Setting

Remember, the best marketing objectives are SMART:

• Specific – Objectives should be tightly related to a specific outcome or deliverable. What is it exactly that you would like to achieve as a result of your marketing efforts? Do you want to improve your average time on page, your conversion rate, or your number of email signups? And how much do you want to improve by?
• Measurable – If objectives aren’t easily measured it is very difficult to track how well you’re performing. Thankfully most elements of digital marketing can be easily tracked and analysed, allowing you to see exactly how far you’ve come and how close you are to achieving your objectives.
• Agreed upon – All stakeholders must understandand agree that the defined objectives are the right ones for the business. Do you have all the right people bought into what you are trying to achieve and are they willing to commit the necessary time and resource to make it happen?
• Realistic – With our depth of experience we will be able to tell you how realistic your marketing objectives are. While we aspire to big visions and goals, it is important that the objectives are realistic within the time and investment constraints.
• Time-based– It is no good leaving objectives open-ended. Having a clear timeframe helps to create the sense of urgency required to achieve great things. It also enables us to have regular review points to assess what is working and what isn’t.  

Analyse and Optimise

A well-defined set of marketing objectives is really only half the battle. It is also vitally important that you are properly set up with the right tools to monitor and track your results.

Platforms such as Google Analytics, Search Console, or Adobe Omniture will empower you to understand the impact of your marketing decisions in a far more quantitative manner.

AsOne will help to ensure that these are set up and configured properly, and will invest the time with you to help make sense of the numbers.

Armed with this data, you can then evolve your campaigns over time to ensure that you stay on track to hit your objectives in the quickest time possible.

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Smart to smarter Marketing Objectives

When identifying specific marketing objectives to support your long-term goals, it is common practice to apply the widely used SMART mnemonic. You will know that SMART is used to assess the suitability of objectives set to drive different strategies or the improvement of the full range of business processes.

One of the main reasons that we called our site and service SMART Insights is because we wanted to help marketers succeed through using a more structured approach to planning to give more realistic targets they could be more confident of achieving. Using SMART objectives and then measuring them through properly customised analytics reports is a big part of how we hope to help too.

With SMART objectives documented in Plans linking objectives to strategies and KPIs everyone is sure exactly what the target is, progress towards it can be quickly and regularly reviewed, for example through an Ecommerce dashboard and, if necessary, action can be taken to put the plan back on target.

How can SMART objectives help set realistic targets?

When setting future objectives for marketing such as in a marketing plan it’s useful to look hard at each measure and ask “is it essential?”. The SMART mnemonic helps as a test or filter which you can use to assess the quality of measures. My personal definition of SMART is:

• Specific – Can the detail in the information sufficient to pinpoint problems or opportunities? Is the objective sufficiently detailed to measure real-world problems and opportunities?
• Measurable – Can a quantitative or qualitative attribute be applied to create a metric?
• Actionable – Can the information be used to improve performance? If the objective doesn’t change behaviour in staff to help them improve performance, there is little point in it!
• Relevant – Can the information be applied to the specific problem faced by the marketer?
• Time-bound – Can objectives be set for different time periods as targets to review against?

Of course different people interpret define SMART differently and you can refer to the Wikipedia definition of SMART marketing objectives.

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Marketing Research

Secondary marketing research uses data that already exists and has been collected by someone else for another purpose.

Sources of secondary data can come from within the firm itself – this is known as internal secondary data. External secondary data, on the other hand, is data that has been published by other organisations

What are internal sources of secondary data?

Every department within an organisation will have its own records that represent a potential source of valuable data. For instance, records of past advertising campaigns within the marketing department can be compared with copies of invoices held in the sales department in order to judge their effectiveness and get ideas for future campaigns. Past sales figures can also be used to spot trends and forecast future figures.

The increasing availability and use of loyalty cards and big data has given businesses the chance to gather a wide range of valuable information on customer buying habits, allowing them to target promotional campaigns more effectively.

Internal sources of data should always be considered as a first line of enquiry for any investigation because they are usually the quickest, cheapest and most convenient source of information available. Internal data will also be exclusive to the organisation that generated it, so that rival firms will not have access to it.

However, internal data may be incomplete or out of date, and, if a project is new, there may be no relevant data at all. In such cases, an organisation may need to consider using external sources of secondary data.

What are external sources of secondary data?

There are several sources of existing data available from outside of the business that may be of value. These include:

Commercial market research organisations – including MINTEL, Keynote and Euromonitor

The Government – the much wider availability of open data from the government has significantly increased the availability of such data

Competitors – company reports and websites are easily accessible and contain a limited amount of information

Trade Publication

The general media

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Market Research

There are two sources of information from where data for marketing research can be obtained.

(A) Internal Sources:

These refer to the sources of information within the organisation. In certain cases internal sources are indispensable without which the researcher cannot obtain desired results. Internal sources include accounting information (Trading Profit & Loss A/c and Balance Sheets of different years), salesmen’s reports, statistics in relation to advertisement expenditure, transportation costs etc. Information from internal sources is easily available and no financial burden is involved in gathering the information.

(B) External Sources:

In order to study marketing problems in detail the need of external sources of marketing research arises. External sources are of immense importance and utility in case where research needs detailed and thorough investigation. External sources data can be divided with two categories (a) Primary data (b) Secondary data.

Primary Data:

This refers to the information collected by the researcher from original sources. It is not a published data; it has to be gathered by the researcher himself by tapping various resources. Primary data is usually collected for specific purposes.

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The main sources from where primary data can be obtained are (a) Salesmen (b) Dealers; (c) Consumers etc. It is a very slow process of collecting data and involves huge costs. But results obtained from this data are original and tend to be more accurate and reliable.

These sources are explained below:

(a) Salesmen:

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Salesmen are the most important source of providing first hand information. They are appointed by the owners for the sale and promotion of its products. They have a direct link with the consumers understand tastes, preferences and buying habits of the consumers.

They can also know about the dealer’s reaction (especially of retailers) towards the firm’s products by taking into consideration price, design, packaging and size etc. of the product. The marketing manager may direct the salesmen to prepare periodical reports containing the information collected by them.

The information collected in this manner is original and more meaningful. This will further enhance the morale of salesmen as they feel that they are contributing towards the formulation of marketing policies of the organisation.

But sometimes information provided by salesmen is not accurate and upto the mark. The salesmen are not properly trained and do not know the methodology to collect the information properly.

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(b) Dealers:

This is another source of collecting primary data. Valuable information can be collected with regard to demand of the product from retailers. Information about the marketing policies of competitors can also be gathered from the dealers.

It has been observed that sometimes this method does not prove to be fruitful as dealers do not keep proper records and they do not want to waste their time in supplying information.

(c) Consumers:

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This source of collecting primary data is of great importance. Representative samples of consumers may be selected for conducting thorough investigation with regard to price, quality and use of the product. This method of collection data is very reliable as it establishes direct link between producer and the consumer.

Secondary Data:

Secondary data is already existing which has been collected and published by some individuals or institutions. This data is available at a very low cost and it requires lesser time to collect it.

The main sources of secondary data are:

(a) Periodicals and Newspapers:

Business magazines and journals published periodically contain data which is very useful for marketing research; Newspapers such as Economic Times and Financial Express also contain data regarding business trends and market reports. Important trade journals are Industrial Times, Commerce, Capital, Market, Indian Finance, Business India, Business World and others.

(b) Govt. Publications and Reports:

There are innumerable publications brought by Central and State Govts, which contain valuable data for conducting marketing research. Census reports of the Government of India, Publications of Planning Commission; periodical publication such as Indian Review, various markets bulletins.

Reserve Bank of India bulletin, publication of the Statistical Departments of various State Govts., supply valuable information extensively used in marketing research.

(c) Trade Associations:

Various trade associations like Chambers of Commerce, Export Promotion Council etc, publish useful data which is of immense help to the res warmer.

(d) Published Surveys Of Markets:

This is another useful source of supplying secondary data. Market surveys and reports are important instruments in the hands of researcher for conducting marketing research. These are published by business houses or independent research organisations. These pertain to specific lines of products.

(e) Foreign Govts, And International Agencies:

Publications of foreign Govts, with regard to trade and other important aspects of economy of respective countries and information published by UNO, ILO, IBRD (International Bank for Reconstruction and Development) serve useful purpose in making comparison of Indian conditions prevailing in other countries of the world.

(f) Other Sources:

Besides the above mentioned sources of marketing research, there are many other sources of supplying secondary data e.g., colleges and universities stock exchanges and commodity exchanges, specialised libraries’, internal sources such as sales and purchase records, salesman, reports, sales orders, customer complaints and records of other companies.

The secondary data collected from above mentioned sources suffer from certain limitations. The basis undertaken by different agencies for collecting data may not be comparable. In other words, uniform basis may not be adopted for data collection. The data may be based on incomplete records under secondary source; data is collected for purposes other than marketing research.

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Product orientation v Production orientation

Product orientation and production orientation are closely related concepts. However, one has more to do with the actual product in focus, while the other has more to do with the production of the product. Additionally, product orientation is typically used more in marketing strategy discussions, whereas production orientation is more of a manufacturing concept.

Production Orientation

Production orientation is a general approach to business that focuses on the manufacturing and production processes. Companies that make these processes primary focuses tend to make operational efficiencies and production optimization key objectives in improvement processes. This orientation was prominent during the industrial era and in the capitalism period of the 1950s. Says Law suggests that if a company produces good products, demand will naturally arise.

Traits

With production orientation, the focus is more on the processes of production than what is actually produced. Narrow product lines, pricing based on production costs, technical product research, packaging focused on product protection, and minimal marketing are all common traits associated with a production orientation. These traits are all opposite a marketing orientation, where the company attempts to drive demand through marketing efforts.

Product Orientation

Whereas production orientation exists when management is more concerned with production efficiency, a product orientation is when management is more concerned with product quality. Managers are often obsessed with their products when a product orientation exists. Managers typically believe their products are unique and offer distinct benefits. They focus on consistent improvement of the product with the belief that an ideal product will effectively sell itself.

Challenges

Product orientation does have challenges and is often downplayed by marketing professionals. Management that is overly focused on technology development and endless pursuit of an optimized product may lose touch with the marketplace. Market-oriented companies research and stay connected with changing consumer tastes. This puts product-oriented companies at a special disadvantage in rapidly changing marketplaces where customer needs and product offerings are constantly evolving.

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Sales Oriented Business

Sales-oriented businesses differ significantly from market-oriented business. Bethe Hart, marketing professional and adjunct professor at both Rutgers University and Immaculata College, explains that a sales-oriented business approach has several defining characteristics that set it apart from a market-oriented business. These include the need for aggressive selling methods, a tendency to plan for the short-term rather than the long-term, the need for heavy promotion and the assumption that consumers will buy the product if the company makes it.

Internet Marketing

One example of a sales-oriented business is an online Internet marketing company that attempts to sell consumers any number of different products. This could be, for instance, a business that attempts to sell software to consumers and other businesses to meet their needs. These types of businesses create products that are based on the assumption that the product will meet the need of the business or individual, whether they have expressed a need for the product or not.

Business-to-Business Sales

Business-to-business sales also provide another example of a sales-oriented business approach. Companies develop products that may benefit a business and then rely heavily upon aggressive marketing tactics to sell them. Examples of products sold in this type of market can include advertising sales or technologies such as point-of-sale software and machinery that will allow the business to run more efficiently and profitably. Chances are the business owner was not initially looking for the product, but did so because the salesperson showed him some benefit to buying it.

Door-to-Door Sales

Another traditionally sales oriented-business model that is similar to the business-to-business model is the door-to-door sales method that some companies rely upon to sell their products. These companies will create a supposedly superior product that can be demonstrated in the home and try to show the potential consumer how it will benefit her in the long run. For example, a salesman selling the "world's greatest vacuum cleaner" may attempt to sell the product to the housewife who has a toddler crawling around on the dirty carpet.

Home Improvement

Various types of home improvement products can also provide the occasion for the establishment of sales-oriented business approach. These, too, are sometimes sold on a door-to-door basis, but they are often peddled over the phone first to get the interest of the homeowner and establish an appointment to show the product. While many consumers do have a need or even a desire for such products and may seek them out in a large retail home improvement store, some will inevitably buy products because aggressive sales and marketing professionals approached or contacted them.

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