LEVERAGE (SOLVENCY) RATIOS

Question 1

Leverage (Solvency) Ratios

WHAT IS THE PURPOSE OF LEVERAGE (SOLVENCY) RATIOS?

Answer 1

Purpose: Assess the company’s financial structure and debt management.

There are two types of Leverage (Solvency) Ratios:
1. Debt-to-Equity Ratio
2. Interest Coverage Ratio

Question 2

Leverage (Solvency) Ratios

Debt-to-Equity =

Answer 2

Total Liabilities / Shareholder’s Equity

Debt-to-Equity = Total Liabilities / Shareholder’s Equity

Good if: Lower, typically less than 1.
A ratio below 1 indicates the company relies more on equity than debt. Ratios above 2 might signal financial risk.

Question 3

Leverage (Solvency) Ratios

Interest Coverage =

Answer 3

EBIT / Interest Expense
Interest Coverage = EBIT / Interest Expense

Good if: Higher than 2.
A ratio above 2 indicates the company can comfortably cover interest payments. A ratio below 1 is a red flag.