Solvency ratios Flashcards
What is the purpose for solvency ratios?
Capture trends for covering a firms ability to:
1) keep up with productive capacity ($ to buy/expand prop/plant & equip)
2) cover LT debts (int & principal)
What are the two types of solvency ratios
1) debt ratios
2) coverage ratios
What is the purpose of debt ratio?
The ability of firm to cover debt in comparison to its capital structure
What is LT debt to tangible assets
Long term debt / Total tangible assets
** more restrictive**
What is the interpretation of LT debt ratio
The LT debt ratio tells you the % of debt that the assets cover.
Ex. 2,000 LT debt / 10,000 total assets = 20% (or 20% of the assets are used to cover debt).
Firm’s cap structure is 20% debt and 80% equity
Do you need to know the industry average when interpreting LT debt ratio?
Yes, need to know the industry average. Different industries require different cap structures.
What is the purpose of a coverage ratio?
What is the firm’s ability to generate enough profit to cover interest expenses.
What is the interest coverage ratio?
Operating income before taxes and interest / interest expense
OR
EBIT / interest expense
*a higher number is better - can cover more interest with higher number
What is a criticism of interest coverage ratio?
Operating income does not give you a good idea if the firm has enough cash to pay interest expense.
Cash flow from operations is better numerator.
What is the debt to equity ratio?
Total Liabilities (current & LT) / Total Stockholder’s Equity
What is the LT debt to equity ratio?
LT debt (no current) / Total Stockholder’s equity
What is debt to total assets ratio?
Total Liabilities (current & LT) / Total assets
Derivative - Total liabilities / Tangible assets - more restrictive
What are the debt ratios?
- Debt to equity
- LT debt to equity
- debt to total assets
- debt to tangible assets
What are the solvency (coverage) ratios?
- Fixed Charge Coverage
- Interest Coverage
- Free Cash Flow
- Cash flow to fixed charges ratio
Which statement is needed for debt ratios?
Balance sheet - assets, liabilities + SE
What statement(s) is needed for coverage or solvency ratios?
Need
- Income Statement
a. op income or EBIT
b. interest expense
c. fixed charges (lease oblig) - Balance Sheet
- Statement of Cash flows
- > for Free Cash Flow only
What is the Fixed Charge Coverage ratio?
EBIT + Fixed Charges / (Fixed Charges + Interest Exp)
What is the Free Cash Flow
This is a \$\$. Cash from operations - Capital Expenditures - Cash Dividends ** measures how efficient a firm is in generating "free" cash.
What is the Cash Flow to Fixed Charges ratio?
(Cash from ops + fixed charges + tax payments ) / Fixed Charges
