How the collateral ratio reveals if a company is on the verge of financial collapse

A company’s solvency is what really concerns banks, investors, and creditors. And there is a simple yet devastatingly effective metric to uncover it: the guarantee ratio. This indicator shows you whether a company’s assets are sufficient to cover all its debts, regardless of when the payment obligation matures.

The true meaning of the guarantee ratio

While other ratios like liquidity only observe short-term payment capacity (less than a year), the guarantee ratio broadens the lens. It examines the entire time horizon, including long-term debts and less liquid assets such as machinery and real estate.

Essentially, it answers a crucial question: If we liquidated all the company’s assets today, could we pay off all the debts absolutely?

This is why financial institutions require it when granting loans longer than a year, real estate purchase loans, factoring, or industrial leasing. It is the compass of true solvency.

Calculation formula: surprisingly simple

You don’t need to be a mathematician to understand it:

Guarantee ratio = Total assets ÷ Total liabilities

That’s all. You take all the company’s assets (cash, investments, inventories, properties, machinery) and divide them by all its debts (bank loans, bonds, trade obligations, anything owed).

Interpreting the result: what the numbers mean

The result will tell you exactly where the company stands:

Ratio below 1.5: The company has too much debt. It has fewer assets than liabilities, meaning that even selling everything wouldn’t cover its obligations. High risk of bankruptcy. This is the danger zone.

Ratio between 1.5 and 2.5: The comfort zone. Most healthy companies operate here. They have enough assets to cover debts with a reasonable safety margin.

Ratio above 2.5: Problems start to appear, but of a different kind. Such a company accumulates too many assets without using them efficiently. It may indicate overcapitalization or poor resource management.

Cases that reveal reality

When analyzing Tesla, its numbers showed a ratio of 2.259 based on total assets of 82.34 billion dollars against liabilities of 36.44 billion. Why so high? Because a tech company needs to finance a lot of research with equity, not third-party debt. It’s a deliberate strategy.

Boeing had a ratio of 0.896 (137.10 billion in assets against 152.95 billion in liabilities). Even worse: this deterioration accelerated after the pandemic when aircraft demand collapsed and losses multiplied.

But the most instructive case was Revlon. With liabilities of 5.02 billion dollars and only 2.52 billion in assets, its guarantee ratio was just 0.50. It was not just weak, it was terminal. Bankruptcy was inevitable.

Why this ratio never fails

Here’s the unsettling part: all companies that went bankrupt previously showed a compromised guarantee ratio. It’s no coincidence, it’s causality. When the numbers become unsustainable, bankruptcy is not a remote possibility, it’s destiny.

The ratio works because it is size-agnostic. It applies equally to startups and multinationals. It’s easy to obtain from any published balance sheet. And most importantly: it combines all relevant financial information into a simple number that tells the truth.

What banks really value

When we request an annual renewable credit line, banks prioritize the liquidity ratio. But when we ask for a 10-year loan to buy a factory, or when we request the bank to act as our guarantor before third parties (confirming), then we need a solid guarantee ratio.

It’s the difference between tomorrow’s payment capacity and the payment capacity over the next 10 years.

Context matters more than you think

It’s not enough to calculate the number once. You must analyze the trajectory. A company with a 2.8 ratio today could be in crisis if it was 3.5 two years ago and 4.0 five years ago. Gradual deterioration is often more dangerous than a sudden drop.

Also, compare with your sector. A tech company with a 2.6 ratio is normal. A bank with the same ratio would be in trouble. The industry sets different expectations.

The conclusion every investor should remember

The guarantee ratio is your ally to detect problems before they explode. Use it together with the liquidity ratio and you will have a clear picture of any company’s financial health.

If the ratio drops below 1.5 and continues to decline, don’t wait. Numbers don’t lie, and Revlon is proof of that.