## Liquidity and LT Solvency Ratios

Hello and welcome to the video on

liquidity and long-term solvency ratios. To begin, notice that we’re looking at

the balance sheet of XYZ corporation and that all of the dollar figures are in

millions of US dollars. We’re looking at a comparative Balance Sheet. We have a

balance sheet “as of” or “at” December 31st 20X2 and those would be all of the

figures in column C. And we are comparing that to the Balance Sheet “at” or “as of”

December 31st 20X3. Notice that we have our main categories of the balance

sheet which are Assets and we have current assets at the top and then we

have some property and equipment coming down we have Liabilities we have the

current liabilities and then long-term liabilities and that we have

shareholders Equity at the bottom. Also, note that total liabilities plus

shareholders equity is equal to the figures up here for total assets, which

of course is necessary since it’s a balance sheet, it must balance; total

assets must always equal total liabilities plus shareholders equity. So,

let’s get started on our ratios. Again at the top we’re gonna start with our

liquidity ratios which are also known as short term solvency ratios. Let’s get

started with the current ratio. The equation for the current ratio is

current assets divided by current liabilities. This is a ratio that’s

commonly used in business. I probably would memorize this one and it’s easy to

memorize. So, let’s get started with our equation. We’re gonna to click the formulas tab at the top and then click Autosum. Notice that Excel assumes that I want to

add all of the cells to the left of the cell that I’m in, but that’s not what I

want to do, so I’m just clicking into the cells that I want to use for 20X2.

I’m looking for total current assets so I’m going to click into cell C9 and I’m

going to click the division sign here and I want to divide that by current

liabilities. And, my total current liabilities is this figure which is cell

C28. Then I click enter and I should have any answer there which is zero zero

zero which is not the number I’m looking for so I’m going over to home and adding

some more decimal places to see if I can come up with a figure so I have one

point 1.12 telling me that total current assets fourteen

thousand one hundred and thirty dollars is slightly larger than or is larger

than total current liabilities which is why I have a number which is greater

than one. So now let’s do this for 20X3. We’re going to use the same

formula so we’ll take our formula click the autosum formula, the epsilon figure,

and what we want to do this time is take Total Current Liabilities at December

31st 20X3 and divide that by Total Current Liabilities

at December 31st 20X3. We hit our enter button and we should have… again it’s

rounding it off to zero so let’s go home and fix that with the decimal places.

Okay, so it was rounding to zero because I only had it rounding to one place. So we can see that for 20X3, the total current assets, $11,990 are less than total current liabilities that’s why our answer comes out to a figure that is less than 1. So in general you would like the

current ratio to be at least 1.0, which indicates that you have as many current

assets as current liabilities. Ideally you want to have more current assets and

liabilities. If the current ratio is 1.0 you have exactly the same amount of

current assets as current liabilities so at least 1 or greater is desirable.

Okay, let’s look at the cash ratio and for 20X2 it says N/A, meaning it’s

not applicable – it cannot be computed. The reason it cannot be computed is that I

can’t compute the average current liabilities of 20X2 because I

don’t have the current liabilities for 20X1so without 20X1 I cannot

compute the average so I won’t have number for 20X2. But for 20X3 we can

come down here and we will enter our formula. Let’s see we’re going to need

our cash balance which in 20X3 it’s 2,512 million dollars and we’re

going to divide that by the average current liabilities. So if we come down here a

little bit further you can see that I have total liabilities for 20X3 and

20X2. I can get the average by adding those two figures and then dividing by 2.

So let’s do that first… so we’ll go back to the formula and state that we want to

take this figure and add it to this figure so that’s the total current

liabilities for 20X2 and 20X3 and then I need to move my division sign to the

outside of that parenthesis and say divide that by 2 because I want the

average of those two figures. I come up with $12,665 so let’s just look at these two figures and see if that seems

reasonable. Yes it’s reasonable because $12,000 is in both numbers and

we need the average between $622 and $700, so 665 is a

reasonable number so this is a figure that we’re going to use as the

denominator of our equation up here for the cash ratio. So moving up we will go

to 20X3 and we will compute our balance and we need total cash which

we find in the top cell B5 and we will divide that by the average current

liabilities which we just computed a moment ago and we end up with a cash

balance of …again it’s rounding to less than one decimal place ….that’s a little

too many decimal places so let’s say it’s rounding to point two so that

means our cash compared to our average current liabilities is far less than 1.0.

So we don’t have enough cash on hand to pay our average current liabilities, but

we do have at least for well, we don’t quite, for 20X3 we have not quite

enough current liabilities to pay excuse me, not quite enough current assets to pay our current liabilities but close. But clearly we don’t have enough cash to

pay off the current liabilities. So what does that mean it means we would need to probably collect on some of the receivables or to sell some more

inventory in order to be able to pay the average current liabilities with cash. So

these are short term solvency ratios usually referred to as liquidity ratios.

Let’s come down now and look at long-term solvency ratios and we’re

going to look at two: the total debt ratio so for 20X2 we’re going to look

at total liabilities divided by total assets. In in other words we’re looking

at the debt to asset ratio, so let’s again go to our formula tab, click on

auto sum and we are going to look at total liabilities for 20X2. And

we’re going to come down here to total current liabilities, but I also need total non

current liabilities. I actually need the sum of both, which I do not have so maybe

an intermediate step here would be to add, (I think I have my formula there come

here) the first step is to add the short term liabilities

plus the long term liabilities so that I have a total of liabilities and I’m

going to actually label that line total liabilities so and let’s do the same

thing for the next for 20X2. I just copied this formula and I pasted the

same formula for 20X2. Okay so now we can go up and compute our debt to

assets ratio we’re going to use that auto sum figure and we want to

take total liabilities for 20X2 and we want to divide that by total assets

which is the 40,262 million and we will hit enter and we see that our

figure is .678. I’ll reduce the decimal places in a moment.

Let’s do the same thing for 20X3. We’re going to take the total

liabilities for 20X3, which we just computed a moment ago and we are going to divide that by total assets for the same period and we end up with this

figure here. Okay so let’s go over to home and let’s reduce the decimal places of these two cells and we have 0.68 and 0.71. So, you can see that we have

for total liabilities and total assets remember in the previous ratios we were

only looking at current assets and current liabilities now we’re looking at

total liabilities and you can see that our total liabilities is less than our

total assets, which is why we have a figure that is less than one. So our total liabilities is $26.478 billion and and our total

assets is $37.431 billion So we see that we have more total assets than

total liabilities, which is a good sign. Okay so we have that for 20X2 and 20X3, these figures are showing that it’s increasing so this

would mean what our total liabilities figure is getting larger and we can see

that this is the case here. Total liabilities it’s only slightly larger

but current total total assets is also larger. Okay so what we want, the total

debt to assets figure, we want that number to be getting smaller, not larger.

In other words we want total assets to be larger than total liabilities so as

this ratio becomes bigger that would be more of a bad sign or a negative

indication. Okay the debt to equity ratio the same

thing we want to have more equity than debt so we’re hoping that these figures

are smaller in other words the numerator is smaller than the denominator so let’s

do our formula by pulling up the formula bar, we click our auto sum, and the figure

that we’re looking for is total liabilities

so for 20X2 we’ll say total liabilities and we need to divide that by total

equity, and we have total shareholders equity in this cell, so we click that and

we see that our figure is difficult to see okay and then for 20X3 we’re

going to do a similar formula click the autosum and we’re looking for total

liabilities for 20X3 and we’re dividing that by total shareholders

equity for 20X3 and we have this figure here and let’s go and fix these

decimal places. Son on this one we need to add some decimal places but not that

many, and for this one we’re going to reduce the decimal places, here we go. Okay so we see that total liabilities to

total equity is 2.11 for 20X2. I’m gonna check something here, yes okay, and for 20X3 it’s 2.42. So this number is getting bigger which again that would be

a negative sign or a negative indication that the liabilities are getting larger

than the equity. We want equity to be larger the liabilities, as well as, we

want assets to be larger the liabilities. But the difference is marginal between

the two years. Again all of this depends on which industry you’re in as to whether

these are acceptable ratios or whether these would be considered

unacceptable ratios. In general though the current ratio

should be at least one or higher than one. That is a figure that’s easy to

remember so I highly recommend that you memorize the equation for the current

ratio. Some of the others are actually easy to remember.

So when it’s called: debt to equity ratio for example debt—another word for debt

is liabilities it is total liabilities and think of the word “to” as the

division sign. So we have total liabilities divided by total equity that

is the equation for that one. The total debt ratio, another name for this is actually called the debt to asset ratio. So if it’s written that way that’s easy to

memorize the formula it’s total debt or total liabilities divided by total

assets. Okay so I hope you found this useful and please let me know if you

have any questions. Thank you for listening, bye bye.