Solvency Ratios Flashcards
1
Q
Total-Debt-to-Total-Assets Ratio
A
TD to TA = Short-Term Debt + Long-Term Debt / Total Assets
- Shows the degree to which a company has used debt to finance its assets.
- The calculation considers all of the company’s debt, not just loans and bonds payable, and considers all assets, including intangibles.
- Generally, a ratio of 0.4 – 40 percent – or lower is considered a good debt ratio. A ratio above 0.6 is generally considered to be a poor ratio, since there’s a risk that the business will not generate enough cash flow to service its debt.
2
Q
Debt-To-Equity Ratio (D/E)
A
Debt to Equity = Total Liabilities / Total Shareholders’ Equity
- Can be used to evaluate how much leverage a company is using.
- Higher-leverage ratios tend to indicate a company or stock with higher risk to shareholders.
- Generally speaking, a D/E ratio below 1.0 would be seen as relatively safe, whereas ratios of 2.0 or higher would be considered risky.
3
Q
Times Interest Earned (TIE) Ratio
A
TIE = Earnings Before Interest and Taxes / Total Interest Payable on Debt.
- Indicates its ability to pay its debts.
- A better TIE number means a company has enough cash after paying its debts to continue to invest in the business.
- A ratio greater than 2.5 is considered an acceptable risk. Companies that have a ratio of less than 2.5 are considered a much higher risk for bankruptcy or default and, therefore, financially unstable.
4
Q
Interest Coverage Ratio
A
Interest Coverage Ratio = EBIT / Interest Expense where:
EBIT=Earnings before interest and taxes
- Is used to measure how well a firm can pay the interest due on outstanding debt.
- This ratio is used by creditors and prospective lenders to assess the risk of lending capital to a firm.
- Generally, a ratio of at least 2 is considered the minimum acceptable amount for a company that has solid, consistent revenues. In contrast, a ratio below 1 indicates a company cannot meet its current interest payment obligations and, therefore, is not in good financial health.
