Ratio Analysis: Solvency Ratio

Solvency ratio indicates the degree of creditors’ funds in relation to owner’s equity. The debt component requires fixed interest payments and repayment of the loan. A relatively high proportion of funds contributed by the owners indicates a surplus which shields creditors against possible losses from default in payment. Financial leverage will be the advantage to the equity shareholders if the rate of earnings on capital employed is greater than the rate payable on borrowed funds.

Debt Equity Ratio=Total Liabilities / Total Equity

This ratio measures the portion of  fund of  suppliers, lenders &  creditors  in relation to the shareholders fund.  This ratio indicates the extent to which debt is covered by shareholders’ funds. A lower ratio is always safer than the higher. Low ratio reflects an in-efficient use of equity &  high ratio reflects  the more use of debt than  equity.

Interest Coverage Ratio=Earning Before interest & Tax / Interest on Long Term Funds

This ratio measures the number of times a company can cover its fixed  interest expenses on its long term funds. The lower  ratio indicate that  the company is burdened  due to debt. A company should  maintain interest coverage ratio  1.5 or more.

Proprietor Ratio= Share Holders Fund/ Total Assets

This ratio find the share of shareholders in the total assets. Share holders fund includes equity share capital, preference share capital, general reserve, profit & loss. Total assets includes all non-current assets and current assets.

Assets Turnover Ratio= Net Sales/Total Assets

This ratio gives us the information of net sales in relation of total assets. Net sales means all cash & Credit sale less return inward.

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