Solvency Ratios

Solvency Ratios

measure a firm's financial leverage and ability to meet its long-term obligations

debt ratios

that are based on the balance sheet

coverage ratios

that are based on the income statement.

Debt-to-equity

Total Debt/Total Equity

A measure of the firm's use of fixed-cost financing sources

Increases and decreases in this ratio suggest a greater or lesser reliance on debt as a source of financing.

Debt-to-capital

Total Debt/(Total Debt + Total
Shareholders Equity)

Capital equals all short-term and long-term debt plus preferred stock and equity. The ratio shows the proportion of debt in the capital structure of the firm. Increases and decreases in this ratio suggest a greater or lesser reliance on debt as a source of financing.

debt-to-assets

Total Debt/Total Assets

Increases and decreases in this ratio suggest a greater or lesser reliance on debt as a source of financing.

financial leverage ratio

average total assets / average total equity

Average, here, means the average of the values at the beginning and at the end of the period. A ratio close to 1 indicates that equity is being used to finance assets. If the ratio increases above 1, it is an indication that debt is being used.

Interest Coverage Ratio

EBIT/ interest payments

The lower this ratio, the more likely it is that the firm will have difficulty meeting its debt payment

Debt to EBITDA

Total Debt/EBITDA

indicates how long it would take to repay current total debt from an approximation of operating cash flow:

Fixed Charge Coverage

(EBIT + Lease Payments)/(Interest Payments + Lease Payments)

Here, lease payments are added back to operating earnings in the numerator. They are also added to interest payments in the denominator. Significant lease obligations will reduce this ratio significantly compared to the interest coverage ratio. Fixed charge coverage is the more meaningful measure for companies that lease a large portion of their assets, such as some airlines.