Impact of EBITDA Variability on Empirical Safety Thresholds of Indebtedness and Liquidity Ratios: The Case of Poland

To stay sustainable firms must maintain safe levels of indebtedness and liquidity ratios. Suggested “rules of thumb” for both metrics may be found in corporate finance handbooks. Typically it is assumed that the indebtedness above 60–66% may be deemed hazardous, while it is recommended that current liquidity is kept above 1.20–1.50. However, these benchmarks do not take into account any impact of other risk factors, including variability of earnings. In this paper the empirical safety thresholds for indebtedness and liquidity ratios are estimated on the ground of the sample of 64 Polish public companies which filed for bankruptcy between the beginning of 2009 and the end of 2016. This sample of “bankrupt” businesses is compared to the counter-sample of randomly selected public firms which did not face any bankruptcy filing in the same period. Then the whole sample of 128 firms is divided into two sub-samples, on the ground of past 5-years variation in annual EBITDA. Consistent with expectations, the research found that businesses with relatively smooth income trends may afford much more debt than firms with above-average earnings variability. Likewise, the empirical safety threshold of liquidity ratio is much higher for firms with relatively erratic earnings (as compared to those with more stable profit streams). However, contrary to these findings, companies with relatively volatile EBITDA tend to have above-average indebtedness and below-average liquidity ratios.