The first number we will consider is the "current ratio", which is defined as a company's current assets divided by current liabilities (both of which can be found on a company's balance sheet, which will be in its 10-K report). It measures a company's ability to pay off its short-term obligations. Graham's classic value investing book, The Intelligent Investor, recommends that companies have a current ratio of 1.5 or more. If a company has few short-term assets, then when its short-term liabilities are due, it could be in serious trouble. But the actual ratio you should require will depend company. Here are some scenarios that could affect the current ratio you would require for a business, before you consider investing in it:

If a company has plenty of unused, short-term credit, it should be able to use this credit to deal with liquidity issues, and might be safe with lower credit ratio. And if its business is fundamentally solid, it should be able to obtain new financing when necessary. You'll want to look for certain provisions that may be part of the debt agreements. For instance, a company may have to repay its debt if its interest coverage falls below a certain level, which could lead to a disaster.

If it has a high net income relative to its current liabilities, it should be able to add to its current assets, if necessary, by temporarily cutting down on capital expenditures (though this can't be sustained over long periods of time) and by avoiding dividend payments. This should increase the company's current ratio.

If a company's current assets are mostly cash or short-term investments, that's good, because those can easily be used to pay off current liabilities. This company can have a lower current ratio. If the current assets are mostly inventories, then perhaps the company will have trouble selling these inventories. If they're mostly receivables, perhaps the company will have trouble collecting its receivables. Or it might not collect them in time to pay off its liabilities. A company whose current assets are tied up in inventories or receivables will need to have a higher current ratio.

It's also useful to look at a company's receivables turnover, defined as average credit sales divided by receivables. If we assume that all sales are done on credit, then the receivables turnover is simply sales divided by receivables. If the company's receivables turnover is low, then it takes a while to collect its receivables, and the company should have a higher current ratio.

So, if you're investing in a weak company, you'll want a high current ratio (far higher than 1.5). But a high quality company should be able to operate with a lower ratio. Look at Coca-Cola, for instance. Their current assets are about equal to their current liabilities, resulting in a current ratio of about 1. But the company consistently earns billions of dollars in free cash flow per year, which it can use to pay off liabilities. It has plenty of available credit, so it can borrow money if necessary. And with its high credit rating, it should be able to obtain new financing without any trouble. I don't see any short-term liquidity problems for Coca-Cola, despite its low current ratio.

To analyze long term debt, we'll turn to Graham's ideas about bond analysis, which he discusses in chapter 11 of The Intelligent Investor. Here, he analyzes the safety of bonds. This is important, because if a company's bonds are unsafe, its equity is unsafe.

His main criterion is "interest coverage," which measures how well a company's interest charges are covered by its earnings power. We measure this by dividing a company's operating profit by its total interest payments. Suppose a company's earnings, before interest and taxes, are $5 million. If its annual interest payments add up to $1 million, then its interest coverage is $5 million divided by $1 million, which is 5. Graham recommends that we look at two figures: the company's average earnings over the last seven years, and the company's lowest earnings figure over that period. For public utility companies, which Graham regards as particularly safe, he recommends either that:

1) The company's average earnings, over the last 7 years, is at least 4 times interest charges, or,

2) If you take the amount the company earned in its worst year, and divide that by current interest charges, you'll get at least 3.

For #1, this is Graham's estimate of the company's earning power. If the company has grown, and if you're reasonably sure that the growth is permanent (that is, profits won't shrink to previous levels) then you might be justified in using a higher number. If you want to be aggressive, perhaps you can use the company's current earnings, rather than its average earnings. But don't tell Graham, or he'll roll over in his grave.

For other types of businesses, Graham recommends higher interest coverage ratios; for instance, for industrial companies he says that average earnings should be at least seven times interest charges.

He also points out that, given a certain interest coverage, if interest rates are low, a company will have a harder time paying off its debt. For instance, suppose company A has $20 million in debt and company B has 10 million. Also suppose that company A pays 5% interest and company B pays 10%. Then each company pays $1 million in interest charges. If both companies earn $10 million per year, they both have an interest coverage of 10. But company B can pay off its debt with one years worth of earnings, while it would take two years for company A to do the same. So, Graham recommends an alternative: divide the company's average earnings by the total value of its debt. He recommends that this number be at least 20% for a public utility, and 33% for an industrial company. Of course, these figures are arbitrary. Warren Buffett would want a company to have a lot less debt than this.

Long-term debt, while not due for a while, is still due eventually. If a company is solid, and if it doesn't have too much debt, it should be able to obtain new financing. If not, the company might be forced to pay off its debt. Graham says that a company's debt should be less than its working capital (its current assets minus its current liabilities). The idea is, if a company's long-term debt is less than its working capital, it might be able to use its current assets to pay off its debt. This obviously wouldn't work for a company like Coca-Cola, which has very little working capital. Its long-term debt is, in fact, far higher than its working capital. But Coca-Cola doesn't have that much long-term debt. In fact, its total long-term debt is less than its annual earnings. And the company's credit rating is very high. So, I wouldn't worry about it.

In the company's 10-K (annual report), you'll come across a list of the company's long-term debt obligations, along with when they're due. For instance, it might say something along the lines of: 100 mil is due within one year, 200 mil is due in 2-3 years, 100 mil is due in 4-5 years, and 400 mil is due after 5 years. This should help you get a handle on the company's situation.

You also might want to visit www.moodys.com and www.standardandpoors.com. Look at the ratings of the company's bonds. If they're rated below Baa by Moody's, or BBB by S&P, they are known as "junk bonds." In the event of a bankruptcy, bondholders get paid before shareholders, which means, if the company's bonds are risky, the stock is even riskier. So, these stocks are even riskier than junk bonds. You'll want to be very careful with these types of investments.

Occasionally, a company will take on a lot of debt for a one-time event, such as a large acquisition. This might be okay, since in any given year, the odds of this debt causing a problem is usually pretty low. But if the company has a lot of debt every year, the risk is much higher.

To summarize, you'll need to read the company's entire annual report. You'll then need to decide whether you're comfortable with the company's financial position, both in the long term, and in the short term. There aren't any simple ratios that will determine a company's safety, but if you have doubts about a company's ability to repay its debt, you probably shouldn't invest in it.