LONG TERM SOLVENCY RATIO/

LEVERAGE RATIO

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 LONG TERM SOLVENCY RATIO/
LEVERAGE RATIO

 The leverage ratio may be defined as the financial

ratio that measures the long-term stability and
structure of the firm.
 These ratios indicate the mix of funds provided by
owners and lenders and assure the lenders of the
long-term funds with regard to periodic payment
of interests and repayment of principal amount on
maturity.
 Leverage ratios are of two types:
1. Capital Structure Ratios
2. Coverage Ratios

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 Capital Structure Ratios

 These ratios provide an insight into the

financing techniques used by a business
and focus, as a consequence, on the
long-term solvency position.
 Capital structure ratios show the relative
weight of different sources.

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 Debt-Equity Ratio/Leverage Ratio

 It measures the relationship between long-term debt

and equity.
 It measures the degree of indebtedness of an
enterprise and gives an idea to the long-term lender
regarding the extent of security of the debt.
 Ideal and safe- 2:1

 Debt-equity ratio= Long term debt

Shareholder Fund

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 Debt Ratio/ Debt to Assets Ratio

 It refers to the ratio of long-term debt to the total

of external and internal funds (Capital employed/
net assets)
 Capital employed= Long-term debt+
Shareholders fund.
 It may be taken as net assets.
 Low ratio provides security to creditors.
 High ratio helps management in trading on
equity.
 Debt-ratio= Long term debt
 Capital employed/Net assets
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 Proprietary Ratio

 It expresses the relationship of proprietor’s

(shareholder’s) funds to total assets or net
assets.
 Total of debt ratio and the proprietary ratio will
be equal to 1.
 Higher proportion of shareholder’s funds in
financing the assets is a positive feature.
 It provides security to creditors.

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 Total Assets to Debt Ratio

 It measures the extent to which debt (long-term) is

covered by the assets of the enterprise.
 A higher ratio means higher safety for lenders to the
business. Total Assets to Debt
 We may take net assets (capital employed) instead of ratio=
total assets for computing this ratio also.
Total Assets
 In that case, the ratio will be the reciprocal of the debt
ratio. Long-Term Debt

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 Capital Gearing Ratio

 It shows the proportion of fixed interest (dividend) bearing capital

to funds belonging to equity shareholders, i.e. equity funds or net
worth.
 A company is said to be low geared if the larger portion of capital
is composed of common shareholder’s equity.
 Capital gearing ratio=
(Preference Share Capital+ Debentures+ Other borrowed funds)
(Equity Share Capital+ Reserves & Surplus- Losses)

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