Question

what is meant by a firm having a strong balance sheet? what analytical tools are used to make this judgment?

Answer 1

A firm having a strong balance sheet goes beyond simply having more number of assets than liabilities. Entities that are having strong balance sheet are those which are structured to support the business goals of the organization & also to maximize its financial performance.

The tool that is used to decide on the strength of the balance sheet are ratios. There are some ratios that are used to determine the strength of the balance sheet.

• Current ratio: This is current assets divided by current liabilities. This can decide whether or not a company can pay back its short term liabilities with short term assets.
• Debt ratio: The debt ratio is simply total debt divided by total assets. A debt ratio of less than 1 tells us the company has more assets than debt, so the lower the ratio, the stronger the balance sheet.

Apart from this one must also take a look at the company’s credit rating. Because an investment-grade credit rating by one of the big rating agencies is a sign that the balance sheet is strong