Business Solvency: Deciphering the Guarantee Ratio and Its Importance in Financial Analysis

Why is the guarantee ratio essential for evaluating companies?

The guarantee ratio is one of the most relevant indicators in studying corporate financial health. Although many investors are unaware of its importance, credit institutions constantly use it to determine the reliability of applicant companies. This indicator belongs to the category of ratios derived from the balance sheet, and its calculation is surprisingly accessible even for those lacking advanced accounting training.

Unlike the liquidity ratio —which focuses on short-term payment capacity—, the guarantee or solvency ratio broadens the temporal perspective. While liquidity examines only obligations due within twelve months, solvency encompasses the full spectrum of financial obligations without time restrictions.

Differentiating solvency and liquidity: two complementary tools

Both ratios pursue a similar goal: measuring an organization’s payment capacity. However, their scopes differ substantially. Liquidity answers immediate questions: Can the company meet its upcoming debts? Solvency, on the other hand, questions a deeper reality: Does this company have enough assets to liquidate all its commitments?

This distinction becomes extremely relevant when a company appears to have short-term financial strength but carries structural weaknesses in the medium and long term. The simultaneous analysis of both indicators reveals the full picture.

How the banking sector uses the guarantee ratio

Credit entities calibrate their requirements based on the type of financing requested. For credit lines with annual renewal, they emphasize the liquidity ratio. The same emphasis occurs with leasing contracts or commercial discounts, instruments that demand regular short-term cash flows.

Conversely, when companies apply for loans longer than a year —intended for purchasing machinery, vehicles, or real estate assets— banks meticulously examine the guarantee ratio. The same applies to factoring, confirming, and industrial leasing, products where overall solvency becomes decisive.

The formula: simplicity and analytical power

The calculation of the guarantee ratio rests on a simple expression:

Guarantee ratio = Total assets / Total liabilities

This formula incorporates the entirety of the balance sheet: not only immediately available assets but also less liquid assets such as vehicles and real estate, along with all contracted obligations regardless of their maturity.

Using data from Tesla Inc.'s quarterly balance sheet, we observe:

• Total assets: 82.34 billion
• Total liabilities: 36.44 billion
• Result: 2.259

For Boeing, in the same period:

• Total assets: 137.10 billion
• Total liabilities: 152.95 billion
• Result: 0.896

Interpretation: uncovering what the numbers reveal

A guarantee ratio below 1.5 indicates excessive debt and a high risk of insolvency. Ratios between 1.5 and 2.5 are considered normal within standard financial practices. Values above 2.5 may indicate underutilization of leverage or suboptimal resource management.

However, these metrics require context. Sectoral, historical, and company-specific analysis is indispensable. Tesla shows overvaluation indicators, but its technological business model justifies higher equity requirements; investments in research must be financed internally to avoid critical solvency issues.

The Revlon case: when the ratio anticipates collapse

Cosmetics company Revlon filed for bankruptcy after disastrous management. As of September 2022, it had:

• Total assets: 2.52 billion dollars
• Total liabilities: 5.02 billion dollars
• Guarantee ratio: 0.5019

This figure clearly indicated an absolute inability to meet obligations. The most worrying part: the trend showed decreasing assets while debts accumulated, creating a vicious circle that inevitably culminated in collapse.

Strengths of the guarantee ratio as a tool

This indicator offers significant advantages: it functions regardless of company size, applying uniformly to small, medium, and large capitalizations. Its calculation does not require sophisticated accounting expertise.

Historically, almost all companies that have gone bankrupt previously showed compromised guarantee ratios. When combined with other solvency indicators, it allows identifying weak positions susceptible to highly profitable short operations.

Conclusion: a compass for informed investors

The guarantee ratio is an indispensable tool for diagnosing corporate financial solidity. Its true potential emerges when examining historical trajectories, contrasting successive periods, and constantly comparing it with the liquidity ratio. Both indicators, considered together, provide reliable guidance regarding the management quality of any company in which capital is considered for investment.