Crucial ratios for analyzing the balance sheet

Liquidity Ratios:

  1. Quick Ratio:
  • It shows the ability to meet short-term obligations as we can monetize money very “quickly.”
  • We can turn some of our current assets into cash or sell them if something goes wrong or if we need to.
  • It is very conservative, but it shows a buffer on how fast the company can liquidate its “short-term” assets and monetize them to cover its needs (in the case of a tail-event).
  • It is calculated as (Current Assets – Inventory)/Current Liabilities.
  • As it is a ratio, the higher, the better.


2. Current Ratio:

  • It shows the ability to meet short-term obligations as we can monetize money, but not as quickly as using a quick ratio.
  • From this point of view, it is a less conservative ratio, but it is very important for figuring out how strong the balance sheet is.
  • It is calculated as Current Assets / Current Liabilities.

Solvency Ratios

3. Debt to Equity:

  • It shows the relative proportion of debt to shareholders’ equity, or in other words, it shows the proportion of equity from a debt perspective, which is used to finance a company’s assets.

4. Interest Coverage Ratio

  • This number represents how many times the company can cover the interest payment from earnings (EBITDA)  in a given period.
  • This number is crucial as low figures can be considered dangerous when cash flow stops or is disrupted (tail-event).
  • It is calculated as EBIT (Earnings before Interest and Taxes)  / Interest Expense. Alternatively, as EBITDA/Interest Expense.
  • It shows us that the company can cover its interest payments  X (number) times over its annual EBITDA.
  • The higher, the better.
  • In the case of a market slumpdown, plenty of companies can be seen “as great,” but if their cash flow declines significantly, it can cause big solvency problems. So look for companies with a minimum ratio of 4-5 or higher.


5. Solvency Ratio

  • It shows if the company can meet its liabilities using its cash flow to meet its obligations.
  • It is recommended to be at least 1; under 1 it is weak.
  • Is calculated as (Net Income + Depreciation) / Total Liabilities.

Financial Leverage Ratio

6. Debt to Capital Ratio 

  • This ratio measures the portion of debt relative to overall capital.
  • We can calculate it as % debt on total capital in the company.
  • Avert extreme results.
  • Is calculated as (Debt / Debt + Equity).

7. Debt to Asset Ratio

  • This ratio measures the portion of debt relative to the total assets.
  • In other words, measure how many % of the company´s assets are financed via debt.
  • It is calculated as Total Debt / Total Assets.
  • The less, the better.
  • % depends on the industry.

8. Financial Leverage Ratio

  • This ratio measures the number of total assets relative to the equity.
  • It should be between 1-2, but it depends on the interest rate and industry.
  • It is calculated as Total Assets / Total Equity.


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