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Financial Condition Ratios

How To Use The Financial Strength Comparison Report


Financial strength is an important indicator of the amount of business risk the company is taking. When
business conditions turn bad, financially stronger companies have more staying power. Not only are they
less likely to face insolvency, they are also less likely to find a need to make the sort of drastic cutbacks
that might restrain their ability to grow even after better times resume. Use the Reuters Financial Strength
Ratio Comparison to help you assess the financial condition of any company in which you are interested.

Financial Strength Company Industry Sector S&P 500


Quick Ratio (MRQ) 0.39 0.45 0.94 0.97
Current Ratio (MRQ) 0.58 0.71 1.48 1.47
LT Debt to Equity (MRQ) 0.71 0.63 0.89 0.67
Total Debt to Equity (MRQ) 0.79 0.69 1.03 0.97
Interest Coverage (TTM) 6.94 7.17 5.59 9.06

Each company's Financial Strength information is presented in comparison to its Industry, Sector, and the
S&P 500.

Industry: The company universe is grouped into more than 100 distinctive industries. These industries
have been developed to contain those companies that operate along similar lines of business.

Sector: Industries are grouped into 12 distinct sectors. These sectors represent different segments of
the US economy.

S&P 500: The S&P 500 is used to represent the market as a whole.

The Quick Ratio and Current Ratio at the top of the table are the most stringent tests of financial
strength. They measure the level of liquidity that is or could become available to the company in short
period of time. These ratios are base on the Most Recent Quarter (MRQ).

The Quick Ratio compares a company's cash and short-term investments (that is, investments that could
be converted to cash very quickly) to the financial liabilities the company is expected to incur within a
year's time. A ratio of .80 would mean that cash and cash equivalents now available would cover eighty
percent of expected year-ahead liabilities. The shortfall below 100% might seem alarming at first glance.
But remember, the Quick Ratio is a very stringent test that compares a year's worth of obligations with
cash that, for all practical purposes, is already in the bank.

The Current Ratio compares year-ahead liabilities to cash on hand now plus other inflows the company is
likely to realize over that same twelve-month period. These additional expected inflows include such items
as Accounts Receivable (payments the company expects to receive within a year from customers who
already purchased goods or services) and Inventories (goods the company expects to sell within a year).
The Current Ratio is often above 1.00 (100%).

The LT Debt to Equity Ratio looks at the company's capital base. If the ratio is at 1.00, that means the
company's long-term (LT) debt and equity are equal. Put another way, fifty percent of the company's
capital consists of equity (contributed by shareholder-owners) and the other fifty percent was contributed
by long-term creditors.

The Total Debt to Equity ratio takes into account both long-term and short-term debt. Traditionally, one
would analyze a company's leverage on the basis of its long-term debt, which includes debt that is due
more than one year hence. Long-Term Debt is assumed to be a permanent part of the company's capital
structure. Short-term debt is traditionally regarded as not being part of the capital structure. With trade
debt, for example, a manufacturer might borrow money to finance the purchase of raw material, which is
converted into finished products and sold to customers. Once the company receives the proceeds of these
sales, it immediately repays the money it borrowed in order to finance its raw material purchases. Such
debt is not usually regarded as part of the company's capital base.

But nowadays, borrowing arrangements have become much more flexible. Many companies use short-term
debt as if it was part of the capital structure. This occurs when companies continually refinance the debt as
soon as it comes due. This might be done if a company expects interest rates to fall. Continually
refinancing short-term debts at lower and lower interest rates is preferable to locking the company into a
long-term obligation at an interest rate that will be well above rates that are likely to prevail in the
marketplace next year.

This strategy can be risky. If the company's interest rate forecast proves wrong, its cost structure will
suffer. It may wind up refinancing its short-term debt at a rate that is well above the rate it might have
paid had it borrowed long-term in the first place. Either way, we suggest looking at total debt/equity as an
additional measure of financial leverage as well. When doing so, consider two issues:

The more debt in a company's capital structure, the greater the financial leverage risk. If business turns
weak, there are some costs a company can easily reduce to protect its profits and preserve liquidity. But
interest on debt is generally not among these variable costs. Interest must be paid even when revenues
are falling. Hefty levels of debt and heavy interest expense burdens could led to insolvency if revenues or
operating profits remain weak for a prolonged period.

The larger the Total Debt to Equity Ratio is relative to the LT Debt to Equity Ratio, the more risk the
company faces from the prospect of rising interest rates. But remember, some short-term debt is based
on a corporate forecast of lower interest rates, while other types of short-term debt represents trade
borrowing, such as the above raw materials financing example. You can't always tell for certain what sort
of short-term debt your company has. But you can make some reasonable assumptions by using the
Reuters Report to compare your company's debt ratios with those of its industry peers. A company that
uses short-term debt much more aggressively than others in its industry is probably doing so because it
expects lower interest rates.

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