- 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.
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.