Lesson 6 of 7 · All lessons in this module
- Measurement bases and intangible assets
- Goodwill: recognition, impairment and analysisVideo lesson
- Financial instruments: classification and measurementVideo lesson
- Non-current liabilities: long-term debt and deferred taxes
- Common-size balance sheets
- Liquidity and solvency ratios from the balance sheet
- Integrated cases: a balance sheet ratio set against an industry benchmark
Lesson 6 of 7 · 13 min
Liquidity and solvency ratios from the balance sheet
Liquidity ratios set ever-narrower groups of liquid assets against current liabilities, solvency ratios measure how much of the business is financed by debt, and every ratio needs judgment about what it leaves out.
In short
- Current = current assets ÷ current liabilities. Quick = (cash + marketable securities + receivables) ÷ current liabilities. Cash = (cash + marketable securities) ÷ current liabilities, the strictest test.
- Long-term debt-to-equity = long-term debt ÷ equity. Debt-to-equity = total debt ÷ equity. Total debt ratio = total debt ÷ total assets. Financial leverage = total assets ÷ equity.
- Higher liquidity ratios → more ability to meet current obligations. Higher solvency ratios → more financial risk and leverage.
- Impairments and write-downs cut assets and equity, so debt-to-equity and financial leverage rise and asset turnover rises.
- Limits: accounting differences, mixed businesses (use segments), the current ratio's point-in-time and window-dressing problems, and temporary versus persistent conditions.
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