Beware of bankrupt companies! Look at these three numbers.

In the stock market, there is a term that no investor wants to hear, which is "bankruptcy".

Once a company declares bankruptcy, the stocks held by investors are likely to become worthless.

There are many reasons that can lead to a company's bankruptcy.

One possible reason is that the company has too much debt, leading to insolvency.

In this situation, you can use the debt-to-equity ratio to evaluate the company's long-term debt repayment ability.

Additionally, if a company faces a liquidity crisis, it may also face bankruptcy.

This means that the company encounters difficulties in short-term fund turnover, lacking sufficient cash to pay short-term debts, such as short-term bank loans, employees' salaries, suppliers' payments, etc.

So, what financial indicators can be used to assess a company's short-term debt repayment ability?

In financial analysis, there are three common liquidity indicators, namely current ratio, quick ratio, and cash ratio.

First, the current ratio, also known as the operating fund ratio.

It refers to the proportion of a company's current assets to current liabilities.

Current assets include cash, cash equivalents, accounts receivable, and inventory, assets that can be quickly converted into cash within a year.

Current liabilities refer to short-term borrowings, accounts payable, and employee salaries, debts that a company needs to repay within a year.

Through the current ratio, you can determine whether a company has enough current assets to repay short-term debts.

Generally, a current ratio around 1.5 is considered acceptable.

This indicates that the company has enough current assets to repay short-term debts, with less pressure to repay them in the short term.

If the current ratio is less than 1, it indicates that the company does not have enough current assets to repay short-term debts, investors need to be cautious.

However, not all current assets can be immediately used to repay debts.

For example, inventory, with weaker liquidity, some companies may take weeks or even months to sell the goods.

Therefore, investors sometimes use a more conservative indicator, which is the quick ratio.

The quick ratio refers to the ratio of current assets minus inventory and prepaid accounts to current liabilities.

It measures the company's ability to repay short-term debts without considering the sale of inventory.

Usually, a quick ratio value around 1 is a more reasonable level.

This indicates that the company has enough assets that can be quickly liquidated to repay liabilities.

The smaller the quick ratio value, the higher the company's default risk.

Compared with the previous two indicators, the cash ratio is the most conservative indicator.

It only focuses on the most liquid assets: cash and cash equivalents.

The calculation formula for the cash ratio is cash plus cash equivalents divided by current liabilities.

In theory, if the cash ratio is greater than 1, it indicates that the company has enough cash to repay debts.

If the cash ratio is less than 1, it means that the company's cash holdings are not sufficient to cover all short-term debts.

Generally speaking, liquidity indicators with higher values are better than those with lower values, indicating a lower possibility for the company to face liquidity crises.

However, a too high number is not always a good sign.

Due to the high proportion, it may indicate that the company's assets are idle and not being utilized properly.

On the other hand, the liquidity ratios of different industries may vary, which is related to the company's business model.

For example, the quick ratio in the retail industry is generally much lower than in other industries, because retail companies have a lot of inventory.

Therefore, when using liquidity indicators, it is best to compare companies in the same industry or compare them with the industry average.

In summary, investors can use current, quick, or cash ratios to measure a company's ability to repay short-term debts.

When using liquidity indicators, it is important to make a comprehensive determination based on the industry in which the company operates.

This episode of the video ends here, see you in the next episode.