Liquidity: The ability to convert assets to cash in order to pay current liabilities.
Solvency: An assessment of whether a firm can pay all of its liabilities.
We saw these terms previously in LO3-01. The intention is to figure out whether or not the company has a chance of going bankrupt.
Does the company have enough to pay everything due within a year?
Current ratio = Current assets ÷ current liabilities
Same idea as current ratio, but only includes current assets that are already cash or can immediately be converted to cash.
Quick ratio = Quick assets (cash, short-term investments, and accounts receivable) ÷ current liabilities
How reliant on loans is the company?
Debt to equity = Total liabilities ÷ shareholders' equity
Tells you the margin of safety the company has for covering interest expense.
Times interest earned = (Income + interest + taxes) ÷ interest expense