Is It Financially Strong?
The ratios that show whether a company can pay its bills and carry its debt, how to read them for STU Corp, and how to test them against a bad year.
The short version
Financial strength has two sides. Liquidity is whether a company can meet bills due within the year, measured by ratios like the current ratio and quick ratio. Solvency is whether it can carry its debt over time, measured by debt-to-equity, net debt, and interest coverage, operating income divided by interest expense. Ratios can be defined in more than one way, so check which version you're looking at. The most useful test is a stress test: would the company still cover its obligations in a bad year?
By the end of this lesson, you'll be able to
- Calculate the current ratio, quick ratio, debt-to-equity ratio, and interest coverage
- Explain the difference between liquidity and solvency
- Stress-test a company's financial strength with a bad-year scenario
Why this matters
Profitable companies still fail, usually because they can't pay what they owe when it's due. A strong balance sheet gives a company time to get through a bad year, a lost customer, or a recession. A weak one can turn a temporary problem into a permanent one. This lesson measures STU Corp's strength two ways: in the short term, and over the long run.
Liquidity: paying the bills due this year
The Current ratio. Current assets divided by current liabilities: whether a company can cover the bills due within a year. Glossary compares what a company expects to turn into cash within a year with what it must pay within a year:
Current ratio = Current assets ÷ Current liabilities
The quick ratio is stricter. It leaves out inventory, which can take time to sell and may have to be sold at a discount in a hurry:
Quick ratio = (Current assets − Inventory) ÷ Current liabilities
A ratio above 1 means current assets cover current liabilities. How much above 1 is comfortable depends on the business. A company that collects cash from customers before paying its suppliers can run safely with less.
The rest of this lesson is for members
Still to come in this lesson: Solvency: carrying the debt, Stress-test it, the key takeaways, and 2 quiz questions with explanations.
Membership opens every lesson in the curriculum, the capstone projects, the interactive tools, and the members-only channels in the Hyperion Entities Discord. The first lesson of every module stays free.
Go deeper
- Debt, Covenants, and Credit RatingsCorporate Finance (depth track)
- Capital StructureCorporate Finance (depth track)
- LeasesFinancial Statement Analysis in Depth (depth track)
- Bankruptcy and RestructuringCorporate Finance (depth track)
Notes and sources
- U.S. Securities and Exchange Commission. Beginners' Guide to Financial Statements. Checked 2026-09-30.