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Reading a CompanyLesson 4 of 5 · The numbers

Reading the numbers

Balance-sheet health and survival

Safety metrics ask one question - can this company keep its promises in a bad year? Interest coverage, leverage, liquidity and earnings quality are the four ways of asking it.

7 min readBeginnerLast checked against the product on

Solvency is not the same as liquidity

Two failures look identical from outside and have nothing in common.

Insolvency is owing more than you are worth — the debt is too large for the business underneath it, and no amount of patience fixes that.

Illiquidity is owing it now — the business is sound but the cash is in inventory, or receivables, or a factory, and the payment is due Tuesday.

Perfectly solvent companies fail from illiquidity, which is why leverage ratios and liquidity ratios both earn a place rather than one standing in for the other. Debt-to-equity speaks to the first. The current ratio and interest coverage speak to the second.

Interest coverage is the one to read first

Operating profit divided by interest expense answers the bluntest possible question: how far can profit fall before the company cannot pay its lenders?

A coverage of 12x means operating profit could fall by more than 90% and the interest still gets paid. A coverage of 1.5x means a mediocre year is an event. Debt is not risky in proportion to its size; it is risky in proportion to how little room there is between the profit and the payment.

The metrics in detail

  • Interest coverage

    Investopedia

    EBIT ÷ Interest expense (capped at 20× in Pythia)

    How many times operating profit covers interest bills. Below 2× is often stress territory for non-financial firms.

    Example

    EBIT $500M, interest $50M → coverage = 10× (comfortable).

    EBIT $80M, interest $60M → 1.3× (creditors and equity holders should worry).

    How to read it: Banks and insurers use different capital metrics — don’t apply industrial thresholds blindly.

  • Debt / EBITDA (common credit metric)

    Investopedia

    Total debt ÷ EBITDA

    Rough years of operating profit needed to repay debt. Leveraged buyouts often target under 4×; distressed names can exceed 8×.

    Example

    Debt $6B, EBITDA $2B → 3× leverage.

    Falling EBITDA with flat debt quickly pushes this ratio up — a classic cycle risk (Marks framework).

    How to read it: Guru Pyramid “Safety First” and Marks archetypes lean on leverage-style signals.

  • Current ratio

    Investopedia

    Current assets ÷ Current liabilities

    Short-term liquidity: can the firm pay bills due within a year? Piotroski rewards an improving current ratio year over year.

    Example

    Current assets $5B, current liabilities $4B → ratio = 1.25.

    Below 1.0 means more near-term obligations than liquid assets on the balance sheet.

    How to read it: Inventory-heavy retailers can look “liquid” on paper but still struggle in a downturn.

  • Earnings stability

    Investopedia

    1 − coefficient of variation of 5-year EPS

    Rewards smooth, predictable earnings — Graham’s defensive investor cared deeply about consistency, not just the latest blowout quarter.

    Example

    EPS series: $4, $4.20, $3.90, $4.10, $4.05 → low volatility → high stability score.

    EPS: $2, $8, −$1, $5, $0.50 → volatile → low stability score.

    How to read it: Cyclicals (semis, autos) will always score lower here — that is feature, not bug.

Earnings quality is a safety metric

The last one is less obvious. Reported profit is cash collected plus accruals — revenue recognised before the cash arrives, costs deferred until later. Both are legitimate accounting; neither is cash.

Sloan's finding is that the two halves behave very differently: the cash half of this year's earnings tends to persist into next year, and the accrual half tends to reverse. Companies whose profits are mostly accruals therefore tend to disappoint, and the market appears slow to price this in.

So a wide, growing gap between net income and operating cash flow is a safety signal, not just an accounting curiosity. It is one of the inputs behind Piotroski's F-Score and one reason our Quality pillar looks at cash conversion rather than trusting the earnings line on its own.

What these ratios cannot see

They are all built from the balance sheet, and the balance sheet reports what is on it. Operating leases were famously off it for decades. Pension shortfalls, litigation exposure and guarantees to affiliates may be in the notes rather than the ratios.

A clean set of safety numbers means the reported obligations are comfortably covered. It does not certify that every obligation was reported.

Check yourself

4 questions. Nothing is recorded unless you are signed in, and nothing here affects anything else.

1. A sound business has its value in inventory, receivables and a factory, and cannot make a payment due this week. What is it suffering from?
2. Company A carries far more debt than Company B, but A's interest coverage is 12x and B's is 1.5x. Which is in the riskier position?
3. Net income keeps growing while operating cash flow stays flat, so the gap between them widens every year. What does Sloan's research say to expect?
4. A company shows strong coverage, low leverage and comfortable liquidity. What do these clean numbers certify?

4 questions left. An unanswered question counts as a miss, so the check waits for all of them.

Sources

Further reading