Earnings Basket: How to Determine Debt Capacity for a Company
Many people believe that a company with decent profitability shouldn't pose a significant risk, and they assume its stocks will bring steady profits.
However, as soon as they invest, they might get stuck in a situation where the stock value plummets.
The root cause of this issue is often investors overlooking the company's ability to clear its debts.
Even if the company is making short-term profits, high levels of debt can make it vulnerable to market changes and uncertainties, ultimately leading to bankruptcy.
In this context, moomoo Learn will discuss 4 indicators when evaluating solvency.
Companies with heavy assets or poor cash flow often need to rely on debt to sustain operations, resulting in a higher debt-to-asset ratio. On the other hand, companies with lighter assets or better cash flow tend to have a lower debt-to-asset ratio.
A debt-to-asset ratio below 50% may appear more attractive, however there is no ideal ratio.
Many factors need to be considered when looking at the ratio including the industry and type of debt funding.
A debt-to-asset ratio below 50% may appear more attractive, however there is no ideal ratio.
Many factors need to be considered when looking at the ratio including the industry and type of debt funding.
The current ratio measures how many times a company's current assets can cover its current debts.
A current ratio of 3 may indicate a company has enough current assets to cover its current liabilities with a margin of safety.
A current ratio of 3 may indicate a company has enough current assets to cover its current liabilities with a margin of safety.
It is a more stringent liquidity metric because inventory may be difficult to convert quickly to cash and its prepaid expenses may not be refundable.
A current ratio of 2 may indicates a company has enough liquid assets to cover its current liabilities with a higher margin of safety.
A current ratio of 2 may indicates a company has enough liquid assets to cover its current liabilities with a higher margin of safety.
The ratio is considered the most conservative metric of creditworthiness because cash and cash equivalents are readily available to meet obligations.
A higher-than-1 cash ratio may be considered desirable.
A higher-than-1 cash ratio may be considered desirable.
However, it's important to note that some companies may have sufficient cash reserves, such as Apple and Starbucks, which they may use to make dividend payments or share buybacks. These actions can reduce their levels of cash, current assets, and total assets, making their solvency metrics less indicative. Therefore, it's essential to study the solvency of these companies on a case-by-case basis, taking into account their unique financial circumstances.
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Disclaimer: Moomoo Technologies Inc. is providing this content for information and educational use only.
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D Blaine : On the “current ratio” the company logos don’t match the companies noted?
Moomoo Learn OP D Blaine : Thanks for your feedback. It was a mistake that has been corrected.
102513680 : thanks, this is informative
funny Giraffe_6930 : trying to learn all of this. Thank you!
Moomoo Learn OP 102513680 : We appreciate the feedback! It's a great honor to be helpful to you.
Moomoo Learn OP funny Giraffe_6930 : Well done！Thanks for your likes. Hope you enjoy your learning journey here.
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