Liquidity, Solvency and Capital Structure

Liquidity (The Short Term) (Liquidity vs. Solvency - Understanding the Time Horizon)

Focuses on a company’s ability to meet immediate, “due now” obligations using its most liquid assets

Solvency (The Long Term) (Liquidity vs. Solvency - Understanding the Time Horizon)

Focuses on the ability to sustain operations indefinitely and repay long-term debt and interest

The Difference (Liquidity vs. Solvency - Understanding the Time Horizon)

A company can be solvent (high value in land / buildings) but illiquid (no cash to pay this week’s wages). Conversely, a liquid company can be insolvent if its total liabilities exceed its total assets.

Current Ratio (CR) (Primary Liquidity Ratios - Measuring the Safety Net)

Current Assets / Current Liabilities, measures if the company has at least $1.00 in assets for every $1.00 of debt due this year

Quick Ratio (The Acid Test) (Primary Liquidity Ratios - Measuring the Safety Net)

(Cash + Marketable Securities + Accounts Receivable) / Current Liabilities, a more conservative test that removes inventory, which may be slow to sell or obsolete

Cash Ratio (Primary Liquidity Ratios - Measuring the Safety Net)

(Cash + Marketable Securities) / Current Liabilities, the “worst-case scenario” metric - can we pay bills if sales stop tomorrow