Tuesday, 2 September 2014

Liquidity (Practical Experience)

Liquidity is used to assess whether a company can repay its loan in short period. If company cant pay out its loan in time, it will face big problems ( borrow loans with high interest or sell assets to repay its loan).

To be safe, cash ratio should be more than one. Current ratio should be more than 2. for a constant profitable company.

There are two different opinions when considering using high debt ratio. Aggressive investors prefer high debt because high debt means high leverage which in turn means high growth of revenue and profit in the future. However, high debt ratio also means high danger because higher interest expense need to be paid for debt (fixed cost).

My advise is, if you are going to investigate the company thoroughly, then you can choose company with high debt ratio. Because it needs better understanding of company itself and the whole industry in order to predict the successfulness of the company using debt.

If you are not going to do so, better play safe and choose the company with low debt ratio.

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