Debt Ratios

I look at Liquidity Ratio, the Debt Ratio, Leverage Ratio and Debt/Equity Ratio. For these ratios, I look at the ratios for the last financial year end and from any current financial statements. I also look at the averages for these ratios over the past 5 and 10 years. For the Liquidity Ratio, I also look at how they would be adjusted for cash flow less dividends and adjusted for cash flow less dividends and cash flow investments.

The Liquidity Ratio is comparing current assets to current liability. Generally speaking, what you want is a ratio that is 1.50 or above. If the ratio is below 1.00, that means that the current assets cannot cover the current liabilities. With this ratio, higher is better.

For the Liquidity Ratio, if it is low, you might want to see if they are including the current portion of long term debt in the current liabilities. If so, you could remove this value from the current liabilities, if the long term debt has been taken care of. You have to look at the notes section after the financial statements to see the status of the current portion of long term debt.

With other stocks, the cash flow is important when it can be consistent, for example on utility stocks. This is especially true if the Liquidity Ratio is low. Also for some industries, the standards are different or the Liquidity Ratio is just not of much importance. The basic exception is financial institutions.

In my spreadsheets, I use current assets to current liabilities. Also, this is sometimes called the current ratio. For a good tutorial on liquidity ratios see Investopedia.

The Debt Ratio is comparing assets to liabilities. Generally speaking what you want is a ratio that is 1.50 or above. However, this can change with industry, with Financials coming in just above 1.00. With this ratio, higher is better. For more information, see Investopedia.

For Leverage Ratio and Debt/Equity Ratio there is no particular ratio that you are looking for. These ratios tend to vary with industries. These ratios on financial stocks tend to be quite high and other types of companies, like industrials these ratios tend to be low. You really have to compare the company's ratios with the company's past ratios and with like companies. With these ratios lower is better.

For more information on the Leverage Ratio, see Investopedia. For a good article on Debt/Equity Ratio, see Investopedia.

This blog is meant for educational purposes only, and is not to provide investment advice. Before making any investment decision, you should always do your own research or consult an investment professional. See my site for an index to these blog entries and for stocks followed. Follow me on Twitter.