The long-term financial soundness of any
business can be judged by its long-term creditors by testing its ability to pay
interest charges regularly and its ability to repay the principal as per
Thus long-term financial soundness (or
solvency) of any business is examined by calculating ratios popularly, known as
leverage of capital structure ratios. These ratios help us the interpreting
repay long-term debt as per installments stipulated in the contract.
Following are the most important solvency
- Debt-Equity ratio:
(also known as
debt to net worth ratio). The relationship between borrowed funds and
internal owner's funds is measured by Debt-Equity ratio.
Read more about debt equity
- Debt Service or Interest Coverage Ratio:
The ratio measures debts servicing capacity of a business so far
as interest on long-term loans is concerned. The ratio is calculated with
more about debt service ratio.
- Debts to Total Funds or Solvency Ratio:
Solvency is the term which is used to describe the financial position of
any business which is capable to meet outside obligations in full out of its
own assets. So this ratio establishes relationship between total liabilities
and total assets.
Read more about debts to total ratio.
- Reserves to Capital Ratio:
ratio establishes relationship between reserves and capital.
Read more about
reserves to capital ratio.
- Capital Gearing Ratio:
It is the
ratio between the capital plus reserves i.e. equity and fixed cost bearing
securities. Fixed cost bearing securities include debentures, long-term
mortgage loans etc. Read
more about capital gearing ratio.
- Proprietary Ratio:
ratio (also known as Equity Ratio or Net worth to total assets or
shareholder equity to total equity).
Read more about proprietary