In personal finance, debt is normally considered a bad thing. For corporations, however, liabilities are everyday business: Money is borrowed, invested and (hopefully) generates higher returns than if no loans were taken up at all. Obviously debt should not exceed a healthy extent, so that the company’s success is not compromised: Liquidity is the key. Based on a company’s balance sheet, a number of ratios can be calculated that will help getting an impression of the liquidity.

Current ratio:
The current ratio are the current (or short-term) assets divided by the current liabilities. A current ratio of exactly 1 would mean that all short-term liabilities could be paid off with all the short-term assets. Usually, a ratio between 1 and 2 is considered good. A ratio of below 1 indicates liquidity problem, while a ratio of more than 2 signals that a company has too much cash or too much unused inventory.

Quick ratio:
The disadvantage of the quick ratio is that it also considers fixed assets. However, not every item can be liquidated on short notice, or if so, than not necessarily at its book value. Thus the quick ratio ignores fixed assets. Instead it adds the available cash and the short-term receivables and divides the sum by the short-term liabilities. Again, a ratio of less than 1 indicates problems.

Equity ratio:
The equity ratio tells you how much of a company’s assets are covered by equity. To calculate it, you just divide the equity by the total liabilities. Whether the ratio is good or not strongly depends on the industry, the company size and the region. German SMEs, for example, have a relatively low equity ratio. The same goes for banks, where a low equity ratio is typical for the business model. In general, a value of more than 40% can be considered solid in most cases. It is also very important to look at the development of the equity ratio over the last years. If it has been decreasing continually, this might be a warning signal; has it been increasing, then that suggests ongoing corporate success.

Dynamic debt-equity ratio:
The dynamic debt-equity ratio shows you how many years a company would theoretically need to pay off all its debt, if the current cash flow would stay the same and no additional loans would be taken. To calculate it, the liabilities are divided by the cash flow. The result is the theoretical number of years; the lower, the better. Often the ratio is given as a percentage, so 100% stand for one year.