hello I'm Professor Brian B welcome back in this video we're going to talk about liquidity ratios both short-term and long-term liquidity and then we'll apply those ratios to the plane view technology case let's get started here's an overview of all the liquidity ratios we're going to look at and you can put them into three buckets two short-term buckets and one long-term bucket first we have a number ratios that are going to tell us whether we have enough assets that are going to turn into cash to cover our liabilities in the next period then the next bucket will look at specifically whether we have enough liquidity to meet interest obligations and the third bucket is going to be the long-term liquidity ratios and these are going to be more about the notion of riskiness is the firm too highly levered is there a potential risk of bankruptcy down the road that may cause Equity investors to lose their investment what's the company's borrowing capacity those are all the questions that this set of ratios will get at so going to that first bucket of short-term liquidity ratios we're trying to answer the question does the company have enough cash coming in to cover its obligations to pay out cash in the near term ideally all the ratios that we look at would be over one which means there's more cash coming in than cash we have to pay out but again you'd have to Benchmark this with the industry the firm across time because for some Industries these are not greater than one the first ratio is called the current ratio it's current assets over current liabilities and basically what this is trying to get at is if current assets are going to turn into cash in the next year current liabilities have to be paid in cash in the next year do we have enough assets turned into cash to cover the liabilities that we have to meet in cash one drawback to this ratio is as we know not all current assets turned into Cash some of them are things like prepaid rent which never turn into cash some are inventory which take a longer time to turn into cash so there's another ratio called the quick ratio which is just Cash Plus receivables divided by current liabilities much more conservative ratio saying do you have enough assets that are either cash or going to turn into Cash very quickly to cover your current liabilities one more ratio is cash flow from operations to current liabilities so we divide cash on operations by average current liabilities this is more backward looking it's saying over the past year did you have enough cash generated from operations to cover your average level of current liabilities so here's what the ratios look like for plane view so why don't I put up the pause sign and you can take a look at them okay I guess there there are no insights or questions from the virtual students so I'll I'll go on myself starting with the current ratio it looks very healthy it's trended upwards from 2. 4 to 3. 6 the 3.
6 means that plane view has three and a half times as much current assets as it does current liabilities now as we talked about a problem with this measure is that inventory and prepaids are not necessarily going to turn into cash so we have the quick ratio which is Cash Plus accounts receivable current liabilities that also looks good it's been trending upward and it's now actually over one when we look at the cash flow to current liabilities ratio it's not quite as strong we see the volatility in cash flow that we've seen earlier in our ratio analysis and this is trending down but overall I think we can say that plain views short-term liquidity position looks pretty strong they seem to have enough cash that's going to come in to cover the payments they need to make out next we're going to look at the interest coverage ratios here the question is does the company have enough cash coming in from operations to cover its interest obligations and again ideally these ratios would all be over one the first ratio is the interest coverage ratio which is operating income before depreciation divided by interest expense so this is a picture of Interest coverage from an acral accounting perspective so if we look at the sales revenue Vue we take out cost of goods sold we take out sgna and then we ignore depreciation since that's not ever going to be a cash flow is that operating income enough to cover what we have in interest expense we also have a purely cash-based measure so cash interest coverage is Cash operations plus cash interest paid plus cash taxes what we're doing there is those are subtracted from cash from operations but we want to add them back to get pure cash operating the business so the question is is that cash from operating the business enough to cover the cash interest paid so here are the interest coverage ratios for plane view I will put up the pause sign and you can take a look hm nothing again from the virtual students why don't we go and check on them H what does that say Dear Professor sorry we are studying for the exam see you next video your students okay I guess I have been going on too long about ratio analysis and I do realize you've got an exam to do so just give me a few more minutes and I'll wrap this up okay so let me go through the interest coverage ratios the interest coverage ratio looks really strong wrong there's an upward Trend and now it's 6. 9 which means that plane views operating income before depreciation is almost seven times as much as its interest expense when we look at the cash interest coverage it also looks strong except for that one year where there was the negative cash from operations but the current ratio is 3. 8 which means that plane views operations is generating 3.
8 times as much cash as they need to cover their cash interest costs so it looks like in general plan view is in a good position in terms of generating cash to cover its interest obligations now we're going to look at long-term liquidity ratios these ratios are going to tell us something about how the company's financing its growth as well as provide a measure of bankruptcy risk the idea is the higher the company's leverage the bigger the risk that it may have to default on its debt payments and then the company gets forced into bankruptcy hurting the equity investors first ratio is debt to equity which is just total liabilities over shareholders Equity so for each dollar of investment by shareholders how many dollars of liabilities has the company taken on sometimes we put total assets in the denominator and we'll especially do that if shareholders Equity is really small because that could distort this ratio the next ratio specifically looks at long-term borrowing so it's long-term debt to equity total long-term debt divided by total shareholders equity and this is getting at how the company is financing its long-term growth is it using Equity or is it using long-term borrowing and the final ratio is a little tweak on that it's long-term debt to tangible assets so total long-term debt divided by total assets minus intangible assets intangible assets are things like contractual rights uh they're not physical assets they're not property plant equipment so essentially we're trying to get a measure of things like property plant equipment accounts receivable inventory and we're trying to get a measure of that because those are the kind of assets that can be collateralized in other words you can borrow the money with those assets as collateral whereas intangible assets are harder to collateralize so it's the borrowing capacity that the company has based on its collateralizable assets if collateralizable is the word so here are the long term debt ratios for plane view let me go ahead and put up the pause sign and you can take a look let's take a look at these long-term debt ratios for plane view in this case lower ratios are generally better than higher ratios because they would indicate less risk more bow and capacity to fund growth so plane views debt to equity has risen over this period but it's still only 1.
