How to analyze business solvency: a complete guide to the guarantee ratio

Why Are Banks Obsessed with the Guarantee Ratio?

When you apply for a significant loan from a financial institution, there is one indicator that analysts review again and again. It’s no coincidence. This metric, known as the guarantee ratio or solvency ratio, is essentially the compass they use to determine whether your company can meet all its financial obligations. Unlike the liquidity ratio, which measures your short-term payment capacity, the guarantee ratio broadens the perspective and assesses your financial strength considering all debt, regardless of maturity date.

The Concept Behind the Guarantee Ratio

Corporate solvency boils down to a fundamental question: Does the company have enough assets to cover all its debts? The guarantee ratio answers precisely this. It is an indicator that is part of the balance sheet ratios, those extracted directly from the company’s financial position statement.

The important thing is to understand the difference with its close cousin, the liquidity ratio. While the latter focuses on assets and liabilities with less than one year to maturity, the guarantee ratio includes total equity and total debt, without time restrictions. That’s why it is especially valuable: it reveals whether the company is structurally healthy or burdened with unsustainable debt.

The Simplified Formula: How to Calculate the Guarantee Ratio Step by Step

The calculation is straightforward and anyone can do it with the data from the balance sheet:

Guarantee Ratio = Total Assets / Total Liabilities

To get these figures, access the company’s quarterly or annual financial report and locate the line for “Total Assets” (total assets) and “Total Liabilities” (total liabilities). Then perform a simple division. Let’s see this in practice with two real cases.

Practical Application: Tesla versus Boeing

Take Tesla Inc.’s balance sheet with total assets of $82.34 billion and total liabilities of $36.44 billion:

Guarantee Ratio = 82.34 / 36.44 = 2.259

Now compare this with Boeing, which reported total assets of $137.10 billion against liabilities of $152.95 billion:

Guarantee Ratio = 137.10 / 152.95 = 0.896

The numbers speak for themselves. Boeing appeared heavily indebted, while Tesla showed a stronger position. But what do these figures exactly mean?

Interpretation: What Do the Numbers Indicate

The result of the guarantee ratio falls into three ranges that define the solvency status:

Ratio below 1.5: The company is over-indebted. Its liabilities weigh more than what its assets can comfortably support. The risk of insolvency is high.

Ratio between 1.5 and 2.5: The comfort zone. Companies operate here under a financial structure considered normal and healthy in terms of debt-to-assets balance.

Ratio above 2.5: Paradoxically, very high numbers can indicate underutilization of leverage. The company accumulates excessive assets without efficiently leveraging external financing. This is common in tech businesses where internal investment in R&D is crucial.

Context Is Crucial: Sectors and Temporal Evolution

You cannot interpret these numbers in isolation. Industry and history matter. Tesla shows high numbers typical of tech companies that need substantial financing but generate high returns when the investment pays off. Boeing went through a crisis after the pandemic that severely deteriorated its ratio.

To get an accurate diagnosis, graph the evolution of the guarantee ratio year over year and compare it with sector competitors. Also, combine it with the liquidity ratio for a complete view: one shows short-term health, the other long-term sustainability.

Differences in Requirements Based on the Financing Product

Banks calibrate their requirements according to the type of operation:

• Credit lines and leasing: Prioritize the liquidity ratio because they are renewed annually
• Long-term loans, industrial leasing, factoring: Require a solid guarantee ratio
• Confirming: Especially require good solvency since the bank acts as a guarantor

Early Warning Case: Revlon’s Collapse

Revlon, the cosmetics giant, declared bankruptcy after disastrous financial management. As of September 30, 2022, before the official collapse, the numbers were telling:

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

A ratio below 0.5 was a blinking red siren. The company not only couldn’t pay its current obligations; the gap widened month by month. Assets were being liquidated while debts persisted. This indicator would have alerted any investor months before the official bankruptcy announcement.

Advantages of the Guarantee Ratio as a Tool

This indicator stands out for several reasons:

• Universality: Works equally for small companies and mega-corporations
• Accessibility: Data is public and does not require advanced accounting expertise
• Historical accuracy: Almost every company that went bankrupt previously showed a compromised guarantee ratio
• Complementarity: When combined with other ratios, it generates alerts about weak positions for speculative operations

Conclusion: Your Financial Compass

The guarantee ratio is the thermometer of a company’s structural financial health. It doesn’t tell you everything, but it tells you a lot. Its true power emerges when you view it in a temporal perspective, compare it with industry peers, and integrate it with short-term metrics like the liquidity ratio.

Invest time in understanding this metric. The best investors use it not to predict the future but to avoid visible financial traps in the present.