Learning objectives
By the end you can:
- Compute the current, quick, and cash ratios from any classified balance sheet, and interpret them against the business model rather than against a universal "2.0 is safe" rule.
- Explain, and prove with numbers, why a current ratio below 1 and a negative working-capital cycle can be a sign of strength (Costco, HUL) or a sign of distress (a stretched industrial), and name the disclosures that separate the two.
- Compute debt-to-equity under stated conventions, the DuPont financial-leverage multiplier, gross vs net debt, and net debt/EBITDA, and identify when netting cash against debt misleads (restricted, trapped, or operationally required cash).
- Compute and rank the coverage family: interest coverage (TIE), EBITDA/interest, DSCR with principal, and fixed-charge coverage, including a lease-adjusted computation that works across US GAAP and IFRS/Ind AS reporters.
- Compute all five turnover ratios (total asset, fixed asset, inventory, receivables, payables) with the correct numerators and denominators, convert each into days, and defend the conventions (COGS for inventory, purchases for payables, averages over ending balances).
- Derive the Cash Conversion Cycle (CCC = DIO + DSO − DPO) from a cash timeline, compute it end-to-end for a real Indian and a real US company, and read it as a story: who finances whom in the value chain, and what growth will cost in cash.
- Build Enterprise Value = market cap + debt + minority interest + preferred − cash from a filing, compute P/E, P/B, and EV/EBITDA mechanically, and state the consistency rule that pairs enterprise numerators with pre-interest denominators.
- Sanity-check any of these ratios against sector norms ("what good looks like") and know where the entire toolkit does not apply (banks, NBFCs, insurers).
Prerequisites & connections
Five earlier modules feed this one. M1.03 gave you the classified balance sheet, where the current versus non-current split is the raw material of every liquidity ratio. M1.04 gave you the cash-flow statement, because coverage without cash flow is a half-truth. M1.06 covered receivables, inventory, and the cost-flow assumptions behind DIO and DSO. M1.08 covered debt at amortized cost, leases as debt, and the EBITDA comparability trap, all reused constantly here. M2.01 gave you margins and DuPont, and the financial-leverage multiplier taught there gets its full treatment below.
The ratios feed forward everywhere. M2.03 subtracts operating liabilities from operating assets to build invested capital, and the working-capital logic you learn here is half of that build. M2.04 (cash flow and FCF) explains why a rising CCC eats cash. M2.05 uses these ratios in time-series and peer benchmarking. M2.06–2.08 weaponize them: rising DSO and DIO against sales are the two most reliable shenanigan tripwires ever devised. M3.03 (cost of capital) builds synthetic credit ratings off the coverage ratios you learn here. M3.06 gives P/E, P/B, and EV/EBITDA their valuation meaning. Every Phase 5 sector playbook opens with the question this module trains: which of these ratios matters for this business model?
4.0 Two questions, one toolkit
Profitability ratios ask: is the engine any good? These ratios ask two different questions. First, survival: a company dies when it cannot pay a bill on the day the bill is due — not when margins dip. Liquidity, solvency, and coverage measure distance from that day. Second, velocity: two companies with identical margins are not identical businesses if one turns its assets twice as fast. Efficiency ratios measure the speed at which invested money returns as cash.
Keep one distinction in front of you throughout: stock vs flow. Balance-sheet ratios (current ratio, D/E, net debt) are stocks, a photograph of claims at one instant. Coverage ratios (TIE, DSCR) are flows: whether this year's earnings stream carries this year's obligations. A company can look solvent as a stock and be dying as a flow (asset-rich, cash-poor), or carry heavy debt as a stock and service it effortlessly as a flow (a utility). Experts always read the pair, never one alone.
4.1 Liquidity: the twelve-month survival test
Line up everything the company must pay within a year (current liabilities). Line up everything that is cash or will become cash within a year (current assets). Liquidity ratios are just that comparison, run at three levels of strictness: