Accountancy · Ch 9 — Ratio Analysis
Solvency Ratios
Solvency Ratios
Solvency Ratios measure a firm's ability to meet its long-term obligations and reveal how the firm's assets are financed — through owners' funds or through borrowed (debt) funds.
Debt-Equity Ratio = Long-term Debt ÷ Shareholders' Funds
Shows the proportion of long-term debt relative to owners' funds; a lower ratio indicates lower financial risk, since the firm relies less on borrowed capital.
Total Assets to Debt Ratio = Total Assets ÷ Long-term Debt
Shows how well long-term debt is covered by the firm's total assets — a higher ratio means creditors have a larger cushion of assets behind their claim.
Proprietary Ratio = Shareholders' Funds ÷ Total Assets
Shows the proportion of total assets financed by owners' funds — a higher ratio indicates greater long-term financial stability and lower dependence on outside funds.
Interest Coverage Ratio = Net Profit before Interest and Tax ÷ Interest on Long-term Debt
Shows how many times over the firm's profit can cover its interest obligation — a higher ratio means the firm can comfortably service its debt.
Worked illustration (using the illustrative data of Section 1).
Long-term Debt (10% Debentures) = ₹4,00,000. Shareholders' Funds = ₹8,00,000. Total Assets = ₹14,00,000. Net Profit before Interest and Tax = ₹4,00,000. Interest on Debentures = ₹40,000.
- Debt-Equity Ratio = 4,00,000 ÷ 8,00,000 = 0.5 : 1
- Total Assets to Debt Ratio = 14,00,000 ÷ 4,00,000 = 3.5 : 1 …
Long-term Debt divided by Shareholders' Funds; a lower ratio indicates lower financial risk from reliance o …
Net Profit before Interest and Tax divided by Interest on long-term debt; shows how many times profit can cover the …