One quarter of those which fail have a general indebtedness > 100% (*)
A general indebtedness of < 50% is absolutely healthy.
General indebtedness = debt/total assets
This shows what percentage of a company's total funds is being provided by third party funds, or debt.
Being > 100% indebted means a company's equity assets are negative, due to carrying over major losses:
so its liabilities exceed 100% of its total assets.
Such a situation is unsustainable in the long term (cf.
alarm bell procedure).
= A very bad sign!
Businesses do benefit from having a certain level of debt, however, as interest on debt capital is tax-deductible, for example.
Deducting notional interest also plays a major role in choosing between debt and equity in Belgium.
(*) Source: Companyweb: results based on our own study into causes of bankruptcies.
A business is liquid if it can meet its short-term payment obligations; if not, it is illiquid.
A liquidity of > 1 is considered very good
(= in theory, this business can pay its short-term liabilities if it realises its current assets).
The way this ratio has changed in recent years is highly significant.
If liquidity falls steadily, this means things are getting increasingly worse, and will end up being unsustainable.
How liquid and profitable a business is gives a good idea of how well it is doing.
| Liquidity | Profitability |
|---|
| + | - |
| + | Healthy | Chronically sick |
| - | Temporarily sick | Dying |
(**)
(**) Source: Handbook "Financial analysis process" by Hubert Ooghe and Charles Van Wymeersch (Intersentia)
If a business's customer credit levels are falling, that could be a sign it is not selling so much (so has less receivables) or has tightened up its payment policy because it is short of liquidity.
Most businesses which fail have very low customer credit levels.
If a business's supplier credit levels are rising continuously, that may indicate it cannot pay its suppliers on time and hence is fighting liquidity problems.
NB: with a healthy business, this may be due to a conscious or new payment policy
Setting your customers shorter credit terms means they have to pay sooner.
The longer your payment terms, the more uncertain you are that you will be paid what you are owed.
(= more risk)
If a supplier allows a customer more time to pay, that may mean they have great confidence in them.
Customer credit = cost
Supplier credit = income
