Liquidity Vs. Solvency
liquidity and solvency are related measures that allow investors to look closely at a company's financial health. a company that has high liquidity can easily meet its short-term expenses and has a large number of assets that can easily be converted to cash. if a company finds that it has unexpected expenses but it has high liquidity, it can efficiently sell some of its assets to pay for those expenses without becoming insolvent. solvency refers to a company's ability to operate over the long term. a company that is insolvent must declare bankruptcy because it can not meet its expenses and obligations. investors use liquidity and solvency ratios to determine whether a company can meet its financial obligations and whether it is caring the right balance of debt and equity. with too much debt, interest payments will eat up a large percentage of a company's profits, leaving little money left to reinvest in the company or meet other financial obligations. there are four common liquidity and solvency ratios. two common measures of liquidity are the current ratio, which divides current assets by current liabilities, and the quick ratio, which subtracts inventory from current assets and divides the result by current liabilities. for both ratios, a higher result indicates greater liquidity and greater financial health. one frequent measure used for solvency is the interest coverage ratio, which divides operating income by the interest expense. again, a higher result is better. another common measure of solvency is the debt to equity ratio, which divides a company's debt by its equity. in this case, a lower ratio is better. all four ratios vary by industry but four liquidity and solvency ratios always signal that a company is in financial trouble.