Analysis of debt obligations of companies

Analysis of debt obligations of companiesAn analysis of the debt obligations of companies will be discussed in this article. When studying a company's debt, the two most important ratios that should be paid attention to are the ratio of current assets to the company's current debt obligations and the company's liquidity ratio. The ratio of current assets and current debt obligations of the company, which is an indicator of the company's ability to pay its debt obligations, can be quickly calculated on the basis of information contained in the balance sheet of the company. To do this, you can use the following formula:

 

The ratio of current assets and current debt obligations of the company - = Current assets Current debt obligations

 

As with the other factors that are discussed in this chapter, you should compare the coefficient of the company of interest to you with the corresponding coefficients of other companies representing the same industry.If the ratio of current assets to current debt obligations of the company you are interested in is lower than the corresponding ratio of most other companies representing the same industry, this may indicate that the company you are interested in is experiencing certain problems with paying its short-term debt obligations, and this, in turn indicates that the threat of bankruptcy for this company is very real. If the ratio of current assets and current debt of the company you are interested in turns out to be much higher than the corresponding ratio of most other companies representing the same industry, this can also be a bad sign that may indicate that this company is not efficiently using its assets. For these reasons, traders prefer to deal with companies whose ratio of current assets and current debt obligations is quite close to the corresponding industry average.

 

Fortunately, you do not have to calculate the ratio of current assets and current debt of the company you are interested in yourself, because these factors can be easily found on any website,which presents fundamental statistics. Using data provided on the Yahoo! Finance, we found that the ratio of current assets and current debt to Note Depot is 1.431, and the corresponding figure for Lowe’s is 1.526.

 

The company's liquidity ratio is almost the same as the ratio of current assets and current debt obligations of the company. An important difference, however, is that the numerator does not indicate the value of current assets, but the difference between the value of current assets and the value of inventories. Many financial institutions perform this additional action, as inventories are not so easy to convert into money. The company's liquidity ratio is calculated using the following formula:

 

The liquidity ratio of the company = / current debt

The company's liquidity ratio is of interest mainly to financial institutions that are considering the possibility of providing a short-term loan to any company. To be an acceptable candidate for a short-term loan, a company must have a liquidity ratio of at least 1: 1.Despite the fact that you, as a trader, are unlikely to provide loans to companies, a company that has problems with obtaining short-term loans will almost certainly experience problems with the execution of its short-term debt in the near future. When the market recognizes the existence of such a problem, the stock price of the company will most likely fall.


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