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Solvency Ratios - Test of Long Term Solvency:

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The long-term financial soundness of any business can be judged by its long-term creditors by testing its ability to pay interest charges regularly and its ability to repay the principal as per schedule.

Thus long-term financial soundness (or solvency) of any business is examined by calculating ratios popularly, known as leverage of capital structure ratios. These ratios help us the interpreting repay long-term debt as per installments stipulated in the contract.

Following are the most important solvency ratios:

  1. Debt-Equity ratio:
    (also known as debt to net worth ratio). The relationship between borrowed funds and internal owner's funds is measured by Debt-Equity ratio. Read more about debt equity ratio.
  2. Debt Service or Interest Coverage Ratio:
    The ratio measures debts servicing capacity of a business so far as interest on long-term loans is concerned. The ratio is calculated with formula. Read more about debt service ratio.
  3. Debts to Total Funds or Solvency Ratio:
    Solvency is the term which is used to describe the financial position of any business which is capable to meet outside obligations in full out of its own assets. So this ratio establishes relationship between total liabilities and total assets. Read more about debts to total ratio.
  4. Reserves to Capital Ratio:
    This ratio establishes relationship between reserves and capital. Read more about reserves to capital ratio.
  5. Capital Gearing Ratio:
    It is the ratio between the capital plus reserves i.e. equity and fixed cost bearing securities. Fixed cost bearing securities include debentures, long-term mortgage loans etc. Read more about capital gearing ratio.
  6. Proprietary Ratio:
    Proprietary ratio (also known as Equity Ratio or Net worth to total assets or shareholder equity to total equity). Read more about proprietary ratio.
More study material from this to

More study material from this topic:

Meanings, Nature and Usefulness of Ratios Analysis
Interpretation of Ratios
Important Factors for Understanding Ratios Analysis
Significance and Usefulness Ratios Analysis
Classification of Ratios
Analysis of Short Term Financial Position or Test of Liquidity
Current Ratio
Quick/Acid Test/Liquid Ratio
Absolute Liquid Ratio
Inventory/Stock Turnover Ratio
Debtors / Receivable Turnover Ratio
Creditors / Payables Turnover Ratio
Working Capital Turnover Ratio
Profitability Ratios
Gross Profit Ratio (GP Ratio)
Operating Profit Ratio
Net profit ratio (NP ratio)
Earnings Per Share Ratio
Operating ratio
Expense ratio
Solvency ratios - Test of Long Term Solvency
Debt-equity Ratio
Debt Service Ratio or Interest Coverage Ratio
Fixed Assets Ratio
Debts to Total Funds or Solvency Ratio
Reserves to Capital Ratio
Capital Gearing Ratio
Proprietary Ratio
Accounting Ratios Formulas
Limitations of Ratios Analysis



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