Solvency Ratios

Solvency ratios provide information about a company’s ability to pay off its long-term debt obligations. The ratios give an indication of how reliant a business is on debt for the daily operations. In this category of ratios, the total assets, total liabilities and total equity numbers are compared with each other.

Low solvency ratios can indicate that your business is in a strong position to meet its debt obligations as they fall due. However, it can also indicate that your business is underfunded and could benefit from borrowing more money to invest in high growth opportunities. High solvency ratios are a bad sign that your business has borrowed too much money and is at risk for not being able to pay it back.

The two most commonly used solvency ratios are the debt/equity ratio, debt ratio and interest coverage ratio.

Debt/Equity Ratio = Total Liabilities / Total Equity

The debt/equity ratio considers whether your business has too much third-party lenders money financing your business operations in comparison to the contributions from the owners of the business.

Debt Ratio  = Total Liabilities / Total Assets

The debt ratio considers whether your business has sufficient assets to pay off its entire liabilities at a moment’s notice.

Interest Coverage Ratio  = Earnings Before Interest and Tax / Interest Expense

The interest coverage ratio is a useful indicator that gives lenders comfort regarding the adequacy of a business’s operations to generate sufficient profits to pay the interest on its loans.