Finally, for our analysis, we find the financial strength
What is a ratio that measures financial strength
Quick ratio
This is known as the “acid test” as it measures the liquidity of a company and the capacity it would have to use its assets to pay its short term debts. It tells us in the case of a crisis how many assets it could liquidate to get the money to pay its short term obligations. It focuses on the short term.
Its formula is:
QR= (current assets-inventories)/current liabilities.
In accounting terms, assets are the properties owned by the company and liabilities are the debts and obligations.
Current ratio:
Is known as the current liquidity ratio and measures what portion of short-term liabilities is covered by liquid assets.
It is similar to the quick ratio in that it indicates the company’s ability to meet its short-term debts.
A company is healthy when its assets are greater than its liabilities, so the formula is:
CR= current assets/current liabilities
If it is greater than 1, a company is healthy because its liquid assets are greater than its liabilities.
If it is less than 1, the company is in trouble, as it would have more short term debts.
Debt to equity – total debt to equity:
This ratio indicates the debt to equity ratio, as it measures whether a company’s equity would pay its debts or not. It is therefore useful to know if a company is highly indebted or not.
Its formula is:
DEBT TO EQUITY= debt/equity
If the ratio is 1, your debt is equal to your equity.
If it is higher than 1, you have more debt, which is not good. The higher this number is, the worse.
If it is less than 1, it is very good because you have little debt.
How to determine financial strength of a company
You should look at these ratios and analyse them, and compare them to different periods, or to the sector or industry, but you should not expect them all to be perfect in order to buy shares in a company. That would be very difficult. Nor should you use all of them, there are investors who make an analysis based on the ratios that are considered most important to them and then make a technical analysis. In any case, it is advisable to look at all of them to get a detailed idea of how the company is doing.