Solvency Ratios - BC Bookkeeping Tutorials|dwmbeancounter.com

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Solvency Ratios

Ratios
Solvency Ratios
Solvency ratios measure the ability of a company to pay its long-term liabilities, such as debt and the interest on that debt. These ratios should normally be calculated when financial statements are prepared - monthly, quarterly, and annually.
Times Interest Earned (TIE) Ratio
  • What It Tells Us: Times Interest Earned measures a company‚Äôs ability to pay its interest expense based on its current operating income.
  • Calculation: Earnings Before Interest and Income Tax for a Period divided by Interest Expense for a Period
  • Formula: Times Interest Earned =  Earnings Before Interest and Income Tax / Interest Expense
  • How Normally Expressed: Decimal Number
  • Bad or Good: The lower the ratio (bad), the more a company is burdened by debt expenses. When a company's interest coverage ratio is only 1.5 or lower, its ability to meet interest expenses may be questionable. You should use your financial information to spot trends and compare to industry averages if available.
  • Additional Clarification: A ratio of 0.5 means that you only have $0.50 of earnings for every 1.00 of interest expense. A ratio of 1.5 means you have $1.50 of earnings for every $1.00 of interest.
Example:
Times Interest Earned
Information: Dollars in thousandsMonthQuarter Year
Earnings Before Interest & Income Tax For Period1758201
Interest Expense For Period139
Times Interest Earned17.0:119.3:122.3:1
Earnings Before Interest & Income Tax / Interest Expense
Our example ratios mean that for the month we had $17, for the quarter we had $19.30, and for the year we had $22.30 of earnings for every $1.00 of of interest.
Debt-to-Assets Ratio (Debt Ratio)
  • What It Tells Us: Debt To Assets Ratio measures what percentage of a business's assets is is financed using debt.
  • Calculation: Total Liabilities divided by Total Assets multiplied by 100
Multiplying by 100 converts the decimal to a percent
  • Formula: Debt To Assets Ratio = (Total Liabilities / Total Assets) x 100
  • How Normally Expressed: Percentage
  • Bad or Good: The higher the ratio the riskier the company is to creditors. A ratio equal to or greater than 100% shows that all of a company's assets are funded by debt. A ratio below 100% means that a company's assets are funded with equity and debt. A high ratio means a higher risk; it means that a company has been financing its growth with debt. So, creditors would probably exercise caution when extending credit with a ratio above 60%. You should use your financial information to spot trends and compare to industry averages if available.
  • Additional Clarification: A ratio of 50% (.5) means that you have $0.50 of debt for every $1.00 of assets. A ratio above 100% (1.0) indicates you have more debt than assets. So, a ratio of 150% (1.5) means you have $1.50 of debt for every $1.00 of assets (potential bankruptcy).
Example:
Debt To Assets Ratio
Information: Dollars in thousandsMonthQuarter Year
Total Liabilities For Period131126125
Total Assets For Period210225300
Debt To Assets Ratio62.4%56.0%41.7%
Total Liabilities / Total Assets x 100
Our example ratios mean that for the month we had 62 cents, for the quarter we had 56 cents, and for the year we had 42 cents of debts for every $1.00 of assets.
Debt-to-Equity Ratio
  • What It Tells Us: Debt To Equity Ratio measures a company's debt position as related to its equity. A high ratio means a higher risk; it means that a company has been aggressive in financing its growth with debt. A high debt-to-equity ratio could indicate that your company might have trouble borrowing more money, or that it may borrow money only at a higher interest rate than if the ratio were lower.
  • Calculation: Total Liabilities divided by Total Equity multiplied by 100
Multiplying by 100 converts the decimal to a percent
  • Formula: Debt To Equity Ratio = (Total Liabilities / Total Equity) x 100
  • How Normally Expressed: Percentage
  • Bad or Good: The higher the ratio the riskier the company is to creditors. Generally speaking, a ratio below 100% would be seen as relatively safe, whereas ratios of 200% or higher would be considered risky. You should use your financial information to spot trends and compare to industry averages if available.
  • Additional Clarification: A ratio of 50% (.5 ) means that you have $0.50 of debt for every $1.00 in equity. A ratio above 100% (1.0) indicates you have more debt than equity. So, a ratio of 150% (1.5) means you have $1.50 of debt for every $1.00 in equity.
Example:
Debt To Equity Ratio
Information: Dollars in thousandsMonthQuarter Year
Total Liabilities For Period131126125
Total Equity For Period7999175
Debt To Equity Ratio165.8%127.3%71.4%
Total Liabilities / Total Equity x 100
Our example ratios mean that for the month we had $1.66, for the quarter we had $1.27, and for the year we had 71 cents of debts for every $1.00 of owner's equity.
Bad or Good ? The higher the ratios the riskier the company is to creditors. Our calculated example ratios would not appear to be an area of concern for creditors.




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