Hello learners. In previous lecture we
covered two types of ratio analysis. In this lecture we will be covering third
type of ratio analysis that is solvency ratios. The term solvency refers to the
ability of a business to meet its long term obligations that is debenture
holders, financial institutions providing medium and long term loans and other
creditors selling goods on credit. These ratios specify forms ability to meet the fixed interest and its cost and repayment schedule use related with its
long term borrowings. Important solvency ratios are debt equity ratio, debt to
capital employed ratio, proprietary ratio total assets to debt ratio and interest
coverage ratio. let’s talk about debt equity ratio. This ratio is also known as
external to internal equity ratio. It measures the relationship between
long-term debt and equity. Normally it is considered to be safe if debt equity
ratio is two ways to one however it may vary from industry to industry. Now debt
equity ratio is equal to total long-term debt upon shareholders funds. Next type
of solvency ratio is debt to capital employed ratio. debt to capital employed
ratio refused to the ratio of long-term debt to the total of external and
internal funds. Low ratio provides security to lenders and high ratio helps
management in trading on equity and the next type is proprietary ratio.
proprietary ratio expresses relationship between proprietors funds and net assets
this ratio is used to determine the financial stability of concern in
general. So proprietary ratio is equal to shareholders fund upon total assets now
what is shareholders fund shareholders fund is equal to preference share
capital plus equity share capital plus all reserves and surplus and what is total assets total assets includes tangible
assets plus all non tangible assets plus current assets or all assets including
good will. Moving on to the next solvency ratio which is total asset to debt ratio.
This ratio measures the extent of the coverage of long-term debts by assets
this ratio is expressed as follows total assets to debt ratio is equal to
total assets divided by long-term debts and the last one is interest coverage
ratio which is also known as ICR this ratio is a measure of security of
interest payable on long-term debts. it reveals the number of times interest on
long-term debts is covered by the profits available for interest so
interest coverage ratio is equal to net profit before interest and tax divided
by interest on long term debts. thank you.