Unit 3 — Working With Financial Statements G3

GROUP 3 — Long-Term Solvency & Coverage Ratios

Long-Term Solvency Ratios

Measure a firm's long-term ability to meet its obligations and the amount of financial leverage it uses.

Financial Leverage

The use of debt to finance a company's assets.

Total Debt

Total Assets − Total Equity.

Total Debt Ratio Formula

(Total Assets − Total Equity) ÷ Total Assets.

Total Debt Ratio Meaning

Shows the percentage of the firm's assets financed with debt

Debt-to-Equity Ratio Formula

Total Debt ÷ Total Equity.

Debt-to-Equity Ratio Meaning

Shows how much debt the company uses for every $1 of equity.

Equity Multiplier Formula

Total Assets ÷ Total Equity.

Equity Multiplier Meaning

Measures financial leverage; a higher equity multiplier generally means more assets are being financed with debt relative to equity.

Equity Multiplier Relationship

Equity Multiplier = 1 + Debt-to-Equity Ratio.

Long-Term Debt Ratio Formula

Long-Term Debt ÷ (Long-Term Debt + Total Equity).

Debt-to-Equity From Total Debt Ratio

Total Debt Ratio ÷ (1 − Total Debt Ratio)

Equity Multiplier From Total Debt Ratio

1 ÷ (1 − Total Debt Ratio)

Total Debt Ratio From Equity Multiplier

1 − (1 ÷ Equity Multiplier)

Debt-to-Equity From Equity Multiplier

Equity Multiplier − 1

Coverage Ratios

Measure a firm's ability to cover required financial payments such as interest.

Coverage Ratios: Times Interest Earned (TIE) Formula

EBIT ÷ Interest Expense

Coverage Ratios: Times Interest Earned Meaning

Measures how many times operating earnings can cover interest expense.

Coverage Ratios: Cash Coverage Formula

(EBIT + Depreciation) ÷ Interest Expense

Coverage Ratios: Why Depreciation Is Added Back in Cash Coverage

Depreciation reduces EBIT but is a noncash expense, so it is added back to better measure cash available to pay interest