2.8. Debt, Liquidity, and Solvency
Lesson objective
Analyze obligations and the company's ability to pay.
Debt can finance growth, but it creates interest payments and maturity obligations. Risk depends on revenue stability, currency, interest rates, maturity dates, and available cash.
Current Ratio and Quick Ratio provide a view of short-term obligations. Debt-to-Equity compares debt with equity, although its usefulness differs by industry and accounting structure.
A company with significant cash is not automatically risk-free. Some cash may be restricted, held in other jurisdictions, or required to operate the business.
Separate liquidity from solvency
Current ratio = Current assets ÷ Current liabilities
Net debt = Total debt − Cash
Net debt / EBITDA = Net debt ÷ EBITDAwhen meaningful
Same debt, different risk
Two companies each have $2B debt. A has $1.5B cash and recurring cash flow; B has $100M cash, volatile earnings, and a large maturity next year. The debt headline is identical; risk is not.
Read maturities, rates, covenants, refinancing access, and lease obligations. Timing matters as much as the total.
Essential terms
| Term | Practical meaning | |---|---| | Current Ratio | Current Assets divided by Current Liabilities. | | Quick Ratio | A liquidity measure that excludes less-liquid current assets. | | Debt-to-Equity | Debt relative to shareholders' equity. |
In Finzati
Financial Strength presents Debt-to-Equity, Current Ratio, Quick Ratio, and an overall stability reading.
What you should remember
- Review debt amount, cost, and maturity schedule.
- Compare debt with cash and cash generation.
Practice
Calculate simplified net debt as total debt minus cash, and explain the limitations of this calculation.