Understanding

Solvency Ratio
BY: ANSH PASSI (B.COM HONS.)
 Introduction to Solvency Ratios

• Solvency ratios, which are financial metrics that analyze a company's ability to fulfill its long-term
financial commitments, play a crucial role in determining a company's financial stability.
• These ratios help identify a company's capacity to maintain its operations over a more extended
period by analyzing its financial health and the extent to which it can cover its debt obligations.
This ratio include:
• Debt-to-equity ratio
• Proprietary ratio
• Total assets to debt ratio
• Interest coverage ratio.
Debt-to-Equity ratio
• It is a financial metric that measures a
company's leverage by dividing its total
liabilities by shareholder equity.
• It indicates the degree to which a company is
financing its operations through debt versus
wholly-owned funds.
• DTE ratio of 2:1 is considered as an
appropriate ratio.
• Higher the DTE ratio means higher debts on
the company
 Proprietary Ratio
• The proprietary ratio is an essential metric used to assess a company's financial standing. It
specifically quantifies the percentage of a company's assets that are actually funded
through equity versus debt. By analyzing this ratio, stakeholders can determine how
solvent the company is, as well as gain insight into its overall financial health. This
information is particularly valuable for investors, as it can help them make informed
decisions about investing in the company.
• High ratio means adequate safety for creditors and vice versa.
• PROPRIETARY RATIO= Proprietary funds/Total Assets
 Total Assets to Debt
Ratio
• The debt-to-asset ratio is a financial metric that evaluates a
company's capacity to settle outstanding debts by dividing its total
debt by its total assets. The resulting ratio can provide insight into
the company's financial health and viability, as a higher ratio
signifies a stronger ability to repay debts.
• It measures the extent to which debt is covered by the assets.
• Higher ratio means higher safety for lender.
 Interest coverage ratio
• The interest coverage ratio is a solvency ratio that measures a
company's ability to pay the interest on its outstanding debt. It is
calculated by dividing the company's earnings before interest and
taxes (EBIT) by its interest expenses.
• A higher interest coverage ratio indicates that the company is more
capable of paying its interest expenses and is therefore less risky
for creditors.
• It is meaning full to Debenture holder or lenders of long term
funds.
• It is calculated in Times.
Conclusion and Key Takeaways
Solvency ratios are widely used financial metrics that can
assess a firm's capacity to meet its long-term financial
commitments. It's crucial to factor in different types of
solvency ratios to accurately evaluate the financial status of a
company. By analyzing these ratios, stakeholders will get a
clearer picture of whether the company can handle its debt
and maintain its operations for the foreseeable future.