Published on October 24, 2023

Solvency Ratios

Solvency ratios are financial metrics that assess a company's ability to service its long-term debt and interest. Solvency ratios are also known as financial leverage ratios that compare the company's debt to its assets, equity, or earnings. In other words, how many times the company can cover its debt given its assets, equity, or earnings. Unlike liquidity ratios, solvency ratios have a longer term outlook. Solvency ratios vary from industry to industry, making them less effective when comparing companies between different industries. However, it can be used to highlight anomalies between peers within the same sector. The four common solvency ratios are Equity Ratio, Debt-to-Equity Ratio, Debt-to-Assets Ratio, and Interest Coverage Ratio. Equity Ratio Also known as Equity-to-Assets Ratio, shows how much a company is funded by equity as opposed to debt. A higher Equity Ratio indicates that a larger portion of the company's assets is funded by shareholders' equity rather than debt, which is favorable for the company's financial health. A lower Equity Ratio suggests that the company relies on debt to finance its business. The Equity Ratio formula is: Equity Ratio = Shareholders' Equity / Total Assets Debt-to-Equity Ratio Debt-to-Equity Ratio (D/E) indicates how much of a company's equity is financed by creditors. Debt-to-Equity Ratio also shows how much of the company's debt can be covered should it liquidates its equity. A lower Debt-to-Equity Ratio is favorable for the company's financial health. The formula for Debt-to-Equity Ratio is: Debt-to-Equity Ratio = Total Debt / Shareholders' Equity Debt-to-Assets Ratio The Debt-to-Assets Ratios assesses a company's total debt to its total assets. It shows how leveraged a company is and is an indication of how much the company is funded by debt relative to its assets. A lower Debt-to-Assets Ratio is favorable for the company's financial health. The formula for Debt-to-Assets Ratio is: Debt-to-Assets Ratio = Total Debt / Total Assets Interest Coverage Ratio This ratio evaluates how many times a company can cover its current interest payments with its available earnings. It represents the company's safety margin for paying its interest on debt over a specific period. A higher Interest Coverage Ratio indicates a greater capacity to service its interest obligation. The formula for Interest Coverage Ratio is: Interest Coverage Ratio = EBIT / Interest Expense

Debt-to-Assets RatioDebt-to-Equity RatioEquity RatioFinanceInterest Coverage RatioSolvency Ratios
Published on October 15, 2023

Liquidity Ratios

Liquidity ratio is a class of financial metrics used to measure a company's ability to pay off its short-term liabilities, usually due within a year. Another way to think about liquidity ratio is how easily and efficiently a company can convert its assets into cash so it can service its short-term debts. A higher liquidity ratio suggests that the company is able to cover its short-term obligation. A low liquidity ratio would suggest otherwise. Liquidity ratios should not be used in isolation and are best when combined with other factors. When used as internal analysis, liquidity ratios can be used by comparing prior periods to current operations, assuming the same accounting method is used in that timeframe. When used as an external analysis, liquidity ratios can be used to compare different companies within an industry. It is important to keep in mind that it may not be effective to compare the liquidity ratios between companies across different industries, sizes, or geographical locations. The three common liquidity ratios are Current Ratio, Quick Ratio, and cash ratio in the order of least to most conservative. Current Ratio Current Ratio measures a company's ability to pay off its current liabilities. This is the least conservative liquidity ratio as it includes all current assets. The formula for Current Ratio is: Current Ratio = CA / CL CA = Current Assets CL = Current Liabilities Quick Ratio Quick Ratio measures a company's ability to meet its short-term obligations with its most liquid assets. This means excluding inventory from current assets because inventory is les liquid than cash. Quick Ratio is also known as the Acid-Test Ratio. The formula for Quick Ratio is: Quick Ratio = (C + MS + AR) / CL Where C = Cash or Cash Equivalents, MS = Marketable Securities, AR = Accounts Receivable, CL = Current Liabilities Another way to look at Quick Ratio is: Quick Ratio = (CA - I - E\_prepaid) / CL Where CA = Current Assets, I = Inventory, E\_prepaid = Prepaid Expenses, CL = Current Liabilities Cash Ratio Cash Ratio is the most conservative liquidity ratio and considers only cash and cash equivalents in relation to current liabilities. The formula for Cash Ratio is: Cash Ratio = C / CL Where C = Cash or Cash Equivalents, CL = Current Liabilities

Acid-Test RatioCash RatioCurrent AssetsCurrent LiabilitiesCurrent RatioFinanceLiquidity RatiosQuick Ratio