Lesson 5 of 8 · 12 min
Solvency ratios
Solvency ratios measure the ability to meet long-term obligations: debt ratios show how much of the financing is debt, and coverage ratios show how comfortably earnings cover interest and other fixed charges.
In short
- Debt ratios (balance sheet): debt-to-assets, debt-to-capital, debt-to-equity, financial leverage ratio and debt-to-EBITDA.
- Coverage ratios (income statement): interest coverage = EBIT ÷ interest payments; fixed charge coverage = (EBIT + lease payments) ÷ (interest payments + lease payments).
- In this reading, total debt = interest-bearing short-term + long-term debt. Net debt deducts cash, cash equivalents and marketable securities.
- Higher debt ratios mean weaker solvency; higher coverage ratios mean stronger solvency.
- Companies with stable cash flows and low business risk can carry more leverage; operating leverage limits capacity for financial leverage.
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