Solvency ratios

Solvency ratios check whether the firm can meet its long-term debts. In general: less debt, more safety.

• Debt-equity ratio = long-term debt ÷ shareholders' funds. Shareholders' funds (equity) = share capital + reserves and surplus (+ share warrants and share application money pending allotment).
• Debt to capital employed = long-term debt ÷ (long-term debt + shareholders' funds).
• Proprietary ratio = shareholders' funds ÷ capital employed (or total assets). With debt to capital employed, it adds up to 1.
• Total assets to debt = total assets ÷ long-term debt. The higher, the safer for lenders.
• Interest coverage ratio = profit before interest and tax ÷ interest on long-term debt. It shows how many times the interest is covered by profit.

Example: long-term debt 3,00,000 and shareholders' funds 6,00,000. Debt-equity = 0.5:1; debt to capital employed = 3,00,000 ÷ 9,00,000 = 0.33; proprietary ratio = 6,00,000 ÷ 9,00,000 = 0.67.

Interest coverage uses profit before interest and tax. If profit after tax and tax are given, add them back: for example, profit after tax 36,000 with tax at 40% means profit before tax = 36,000 × 100/60 = 60,000; with interest of 20,000, PBIT = 80,000, so coverage = 4 times.