How to assess financial health: understanding and interpreting the collateral ratio

When we are about to analyze a company’s fundamentals to decide whether to invest in it, we need tools that allow us to measure its long-term repayment capacity. There is a particularly useful financial indicator for this: the guarantee ratio. This metric is part of the so-called balance sheet ratios, calculated directly from the company’s financial position statement.

Unlike other indicators that focus solely on the short term, this ratio provides an aggregated view of the company’s financial strength. Its calculation is straightforward, and its components are always available in public reports, making it an accessible tool for both experienced analysts and individual investors.

Definition and concept of the guarantee ratio

The guarantee ratio, also known as the solvency ratio, measures whether a company has enough assets to cover all its debts. This is critical information that investors and financial institutions constantly analyze.

Although it is conceptually similar to the liquidity ratio —both assess payment capacity—, there is a substantial difference. While the liquidity ratio examines only short-term financial commitments (less than one year), the guarantee ratio extends the time horizon and considers all outstanding debt of the organization, without time limits.

This is fundamental because a company may have sufficient liquidity in the short term but lack the financial muscle needed to face its obligations in the medium and long term.

Use in the banking and financial sector

Credit institutions have identified these indicators as valuable tools for risk assessment. Depending on the requested financial product, banks prioritize different metrics.

In short-term operations (renewable credit lines annually, leasing, trade discounts), institutions mainly focus on the liquidity ratio. This approach makes sense since payments are distributed over short periods.

In long-term operations (loans for acquiring fixed assets, factoring, confirming, industrial leasing), banks demand a solid guarantee ratio. In these cases, the financial institution needs to ensure that the company will have the capacity to respond over years, not months.

Guarantee ratio calculation formula

The equation is simple but powerful:

Guarantee ratio = Total assets / Total liabilities

The necessary data are directly found in the balance sheet: the sum of all assets (both liquid and immediate, as well as less liquid assets like vehicles or real estate) divided by the sum of all liabilities (short- and long-term debts, without distinction of deadlines).

Practical example with Tesla Inc.

Using the latest published results, Tesla reported:

• Total assets: $82.34 billion
• Total liabilities: $36.44 billion

Calculation: Guarantee ratio = 82.34 / 36.44 = 2.259

Example with Boeing

In the same period:

• Total assets: $137.10 billion
• Total liabilities: $152.95 billion

Calculation: Guarantee ratio = 137.10 / 152.95 = 0.896

The results diverge significantly, suggesting very different financial situations that require interpretation.

Interpretation of the guarantee ratio

A figure without context is meaningless. The real meaning of the ratio is revealed when we frame it within established ranges:

Ratio below 1.5: The company shows over-indebtedness. Its debts significantly exceed its backing capacity with assets, greatly increasing the risk of insolvency. This is an important warning sign.

Ratio between 1.5 and 2.5: Considered the healthy range. Companies in this interval maintain an adequate balance between assets and liabilities, reflecting prudent financial management.

Ratio above 2.5: Indicates potential underutilization of debt. The company has many more assets than necessary to cover its commitments, which could signal suboptimal resource management or an excessively conservative strategy.

Contextual considerations

These interpretations are general references, not absolute rules. Business reality is more complex. Each sector, each company, and each historical period have their own characteristics that influence what constitutes a “good” ratio.

Tesla, for example, has a ratio of 2.259, suggesting apparent overvaluation. However, this is due to its business model. Technology companies require massive investments in research and development. This capital is typically own (not third-party), explaining the excess of assets. If they financed this expenditure with external debt, they would face a real solvency problem.

Boeing showed a ratio of 0.896, extremely concerning. This situation was not always the case; the sharp decline occurred after Covid-19, when aircraft demand plummeted, severely affecting its assets while debts remained.

The case of Revlon: a lesson in insolvency

The cosmetics company Revlon recently declared bankruptcy after disastrous management. As of September 30, 2022, it reported:

• Total liabilities: $5.02 billion
• Total assets: $2.52 billion

Calculation: Guarantee ratio = 2.52 / 5.02 = 0.502

This ratio, close to 0.5, clearly indicated the inability to pay. Even worse, the trend was deteriorating: obligations were increasing while assets were progressively shrinking, sealing the company’s fate.

Advantages of this indicator

• Size independence: Works equally for small, medium, or large companies, maintaining its interpretive meaning.
• Accessibility: Does not require advanced accounting knowledge; the numbers are public.
• Predictive power: Historically, companies in bankruptcy showed compromised guarantee ratios beforehand, demonstrating its predictive capacity.
• Combining with other ratios: When applied alongside other ratios (liquidity, profitability, leverage), it provides a holistic view of the financial state.

Conclusion

The guarantee ratio and its joint interpretation with other indicators form the basis of responsible financial analysis. Its true value emerges when examined historically, comparing annual trends and positioning them within sector context.

Smart investing requires understanding not only what the numbers say but why they say it. This ratio, correctly interpreted, offers exactly that: a clear window into the financial health of the companies we consider investing in.