Financial
Solvency
Example

Home Page

Back to
NoteBook
Summary

Download
Demo

Eight ratios describe Solvency

1. Quick Ratio is also known as the Acid Test Ratio. [Quick Ratio = (Cash + Receivable) / (Current Liabilities)]. It measures the ability to meet current liabilities. A 1:1 ratio indicates that the business in a liquid condition. A .25 :1 ratio is concerning.

2. Current Ratio is defined as (Current Ratio = Current Assets / Current Liabilities). It measures the ability to meet current liabilities. A 2:1 ratio is considered normal. A 1:1 ratio is considered appalling.

3. Current Liabilities to Net Worth is defined as (Current Liabilities to Net Worth = Current Liabilities / Net Worth) A ratio less than or equal to 50%) is desireable. 67% or more is very undesirable.

4. Current Liabilities to Inventory  is defined as (Current Liabilities to Inventory = Current Liabilities / Inventory). It measures a firms reliance on selling inventory to pay its current liabilities . A reasonable figure  is 250% (2.5 to 1) for industrial companies.

5. Total Liabilities to Net Worth is defined as (Total Liabilities to Net Worth = Total Liabilities / Net Worth). It is also know as Total Debt to Equity. This ratio measures the amount of assets bought with investors' money and the amount that was purchased with creditors' money. The standard is 61% (.61 to 1) the larger the ratio the more debt money used and the greater a firms difficulty in meeting its financial obligations.

6. Fixed Assets to Net Worth is defined as (Fixed Assets to Net Worth = Fixed Assets / Net Worth). This ratio measures liquidity by comparing "fixed" assets with "fixed" capital. Therefore smaller is better. Greater than 75% (.75 to 1) should merit caution.

7. Days' Sales Outstanding  is also known as Average Collection Period. It is defined as (Days' Sales Outstanding = Accounts Receivable x 365 / Annual Sales). The ratio best expresses the quality of a firms account payable. For Net30 terms Days' Sales Outstanding of between 35 days and 55 days is normal.

8. Inventory Turnover is defined as (Inventory Turnover = Cost of Goods Sold / Inventory) and measures how fast inventory is turned over.