Friday, 25 May 2018

Types of Solvency Ratio

Types of Solvency Ratio

Solvency of an enterprise indicates the company's ability to meet the obligations of financial good short term and long term in case if the company is liquidated.

A company that is solvable implies that the company has assets or wealth that is enough to pay all of his debt and vice versa companies which do not have sufficient wealth to paying what he owes the company called the insolvable. The solvency Ratio is the ratio that describes the company's ability to pay in long-term obligations if the company is in liquidation.

Types of Solvency Ratio

Solvency ratios include:

1. The ratio of debt to capital/Debt to Equity Ratio

The ratio of debt to capital illustrates the extent to which the owners of capital can cover debts-debts to outside parties and is a ratio that measures up to what extent the company financed from debt. This ratio is also called the leverage ratio.

Leverage ratio is the ratio to gauge how good the company's capital structure. Permanent funding is capital structure which consists of long-term debt.

Capital structure is permanent spending which reflects the pondering between long term debt and capital on its own. Own capital is capital that came from the company itself (reserves, profit) or derived from taking part, participants.

So it can be concluded that the debt to equity ratio is a comparison between the total debt (debt smoothly and long-term debt) and capital which shows the company's ability to meet its obligations by using the existing capital.

The ratio of debt to capital is calculated by the formula:

Debt to equity Ratio = Total debt / Equity

the smaller the ratio of debt to capital then the better security and for outside parties best ratio if the amount of capital is greater than the amount of the debt or at least the same.

2. Total Debt Ratio to Total Assets/Debt Ratio

This ratio is a comparison between the total debt by total assets. So this ratio indicates the extent to which debt can be covered by assets. The debt ratio is a ratio that shows the obligation between proportion owned and the entire estate.

This ratio is calculated by the formula:

Debt Ratio = Total Debt / Total assets

When the debt ratio the higher, while the proportion of total assets do not change then the debt owned company gets bigger. Total debt ratio means the larger the financial or the company's failure to restore the ratio of the loan higher.

And vice versa if the debt ratio the smaller the debt then owned companies also will be getting smaller and this means the risk of financial companies restore lending is also getting smaller.

3. Times Interest Earned

Time interest earned is comparison between net profit before interest and taxes with interest charges and is a ratio that reflects the magnitude of the financial guarantees to pay interest on long-term debt.

This ratio is also called the closing ratio (coverage ratio), which measures the ability of the fulfillment of the obligation of annual interest with operating profit (EBIT) and measure the extent to which operating profit could be down without causing failure of fulfillment of obligations to pay interest on the loan.

Time Interest Earned can be calculated with the formula:

Time Interest Earned = Net income before interest and tax / Interest expense

So the ratio of solvency is the ability of the company to meet all its obligations, to pay off the entire debt by using all assets he has in the company if liquidated. Thus the solvency ratio is influential with the company's financial performance so that this ratio has a relationship with the company's stock price.

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