Solvency Ratios

Ratio Description

Formula

Debt Equity Ratio The debt ratio is the ratio of a company’s total debts to its total business capital (equity + debt).

A high debt/equity ratio generally means that a company has been aggressive in financing its growth with debt. However, it may result in volatile earnings as a result of the additional interest expense.

Debt Equity Ratio =

       Debt      /
Debt + Equity

Interest Cover The interest coverage ratio may be calculated by dividing a company’s earnings before interest and taxes (EBIT) during a given period by interest payable on its debts during the same period. Higher interest coverage is considered safe.

Interest cover =

Earnings before Interest and Taxes/
Interest expense

Example:

Based on the data above, solvency ratios would be as follows:

The Company’s debt-equity ratio shows that the company is not much dependent on the external debts i.e. only 30% of total business funds (equity + long term loans) are provided by the debt. Moreover, the ratio of debt is decreasing further in the years 2014 and 2015 due to the fact that the company is not distributing all profit earned rather it is retaining a significant part of profits each year to finance its business growth.

At the same time interest cover is improving year by year due to an increase in earnings before interest and taxes.

Working Capital Ratios

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