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Â In this video, we will define what solvency and liquidity ratios are and

Â look at some of these ratios.

Â We will continue to use Amazon's financial statements from 2015 to calculate

Â these ratios and compare them to Amazon's ratios from prior years.

Â Solvency ratios measure a company's ability to meet its interest and

Â principle obligations on long term debt as well as obligations on long term leases.

Â The first solvency ratio is the debt to equity ratio.

Â This measures how much long term debt a company has for

Â each dollar of shareholders' equity capital raised.

Â It is defined as the ratio of the sum of long-term debt and

Â long-term capital leases divided by total shareholders' equity,

Â all of which come from the balance sheet.

Â Amazon's long-term debt in 2015 was $8.24 bilion and

Â its capital leases were $5.95 bilion.

Â It's total shareholders' equity was $13.38 billion.

Â This gives us a debt to equity ratio to be 1.06 in 2015.

Â That is for every dollar raised through equity capital,

Â Amazon raised $1.06 in long term obligation.

Â Over the last four years this ratio has more than doubled.

Â So there may be concern that Amazon has too much debt.

Â But we will have to check the debt to equity ratios of Amazon's competitors.

Â They may also have similar debt to equity ratios.

Â And it may be that Amazon didn't have as much debt as its competitors in the past

Â but has finally caught up.

Â Another measure that captures how much debt capital a company has

Â is the total liabilities to total assets ratio.

Â This is defined as the company's total liabilities divided by its total assets.

Â Higher this ratio, more the obligations, both short and long term, a company has.

Â Also higher this ratio, the lower equity capital a company has.

Â In 2015, Amazon had total liabilities of $52.06 billion and

Â total assets of $65.44 billion,

Â which gives us a total liabilities to total assets ratio of 0.80.

Â For every $1 in assets that Amazon purchases $0.90 come from

Â various forms of liability.

Â Only $0.20 comes from equity capital.

Â This ratio has been fairly stable over the last four years.

Â Given that debt to equity has risen over the same time, it's likely that

Â Amazon has substituted short-term obligations with longer term obligations.

Â One other solvency ratio is the interest coverage ratio

Â which is also called times interest on.

Â This is based on income statement items.

Â It measures if a company has earned enough profits to make its interest payments.

Â It is defined as the earnings before interest and

Â taxes EBIT divided by interest expense.

Â EBIT is the profit a company is left with after taking care of all expenses,

Â except interest and taxes.

Â Interest is paid from EBIT.

Â In 2015, Amazon had an EBIT of $2.23 billion and

Â its interest expense was $0.46 billion.

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The interest coverage ratio works out to 4.86,

Â that is EBIT is 4.86 times its interest expense.

Â The rule of thumb is that an interest coverage ratio of greater that two

Â is good, anything lower than that is of concern.

Â Except 2014, Amazon has maintained a sufficiently high interest coverage ratio,

Â though it has been on the decline.

Â This could be because Amazon has been taking on more long term obligation

Â which we discussed earlier.

Â Moving on to liquidity ratios,

Â they measure a company's ability to meet its short term obligations.

Â One liquidity ratio is a current ratio.

Â It measures whether a company's current assets are sufficient to meet

Â its current liabilities.

Â It is defined as the ratio of current assets to current liabilities.

Â In 2015, Amazon had current assets worth $36.47 billion and

Â current liabilities worth $33.90 billion which gives us a current ratio of 1.08.

Â For every $1 in current liabilities, Amazon has $1.08 in current assets,

Â the higher this ratio, the better liquidity a company has.

Â A current ratio of two or more is healthy and

Â anything lower may be cause for concern.

Â Amazon's current ratio has been just slightly higher than one,

Â the last four years.

Â However, that may not be of concern as it has a negative cash conversion cycle,

Â which means that its current assets are converted to cash

Â before its current liabilities become due.

Â While the current ratio tells us how easily a company pays off its current

Â liabilities, inventories cannot be used to payoff any of these obligations.

Â It may also be extremely difficult to convert inventory held to cash

Â at short notice.

Â In that sense, inventory is not very liquid.

Â And so it may not be appropriate to include inventory as

Â a part of current assets while calculating these liquidity ratios.

Â The quick ratio makes this adjustment.

Â It ignores inventory as a current asset and

Â is defined as current asset minus inventory divided by current liabilities.

Â In 2015 Amazon inventory was 10.24 billion dollars.

Â It's current assets and

Â current liabilities were 36.47 billion and 33.90 billion dollars, respectively.

Â Subtracting 10.24 billion from 36.47 billion and

Â then dividing by 33.90 billion dollars gives us a quick ratio of 0.77.

Â For every one dollar in current liabilities,

Â Amazon has 77 cents in current assets, excluding new entry.

Â Amazon's quick ratio, has been fairly stable, over the last four years.

Â A concern with the quick ratio is that accounts receivable is

Â also not truly liquid because a company's ability to convert receivables to cash,

Â depends on when it's customers or clients pay.

Â The cash ratio fixes this problem by ignoring all types of current assets

Â other than cash and cash equivalents.

Â It is defined as cash and cash equivalents divided by current liabilities.

Â Amazon had cash and cash equivalents worth $19.81 bilion and

Â current liabilities worth $33.90 bilion in 2015.

Â Dividing the two Amazon's cash ratio comes to 0.58.

Â That is for every $1 in short term obligations due

Â Amazon has $0.58 cents in cash and cash equivalence.

Â The cash ratio has held stable over the last few years and so

Â it doesn't seem to be of concern.

Â This concludes all the financial statements-based ratios.

Â Next time, we will look at the two-point identity

Â which will help us identify why a company's is too high or too low.

Â It helps us identify where is the company doing well and where is it doing poorly.

Â We will also look at one market price based financial ratio.

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