Solvency ratios

Question 1

What is the purpose for solvency ratios?

Answer 1

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)

Question 2

What are the two types of solvency ratios

Answer 2

1) debt ratios

2) coverage ratios

Question 3

What is the purpose of debt ratio?

Answer 3

The ability of firm to cover debt in comparison to its capital structure

Question 4

What is LT debt to tangible assets

Answer 4

Long term debt / Total tangible assets

** more restrictive**

Question 5

What is the interpretation of LT debt ratio

Answer 5

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

Question 6

Do you need to know the industry average when interpreting LT debt ratio?

Answer 6

Yes, need to know the industry average. Different industries require different cap structures.

Question 7

What is the purpose of a coverage ratio?

Answer 7

What is the firm’s ability to generate enough profit to cover interest expenses.

Question 8

What is the interest coverage ratio?

Answer 8

Operating income before taxes and interest / interest expense
OR
EBIT / interest expense
*a higher number is better - can cover more interest with higher number

Question 9

What is a criticism of interest coverage ratio?

Answer 9

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.

Question 10

What is the debt to equity ratio?

Answer 10

Total Liabilities (current & LT) / Total Stockholder’s Equity

Question 11

What is the LT debt to equity ratio?

Answer 11

LT debt (no current) / Total Stockholder’s equity

Question 12

What is debt to total assets ratio?

Answer 12

Total Liabilities (current & LT) / Total assets

Derivative - Total liabilities / Tangible assets - more restrictive

Question 13

What are the debt ratios?

Answer 13

1. Debt to equity
2. LT debt to equity
3. debt to total assets
4. debt to tangible assets

Question 14

What are the solvency (coverage) ratios?

Answer 14

1. Fixed Charge Coverage
2. Interest Coverage
3. Free Cash Flow
4. Cash flow to fixed charges ratio

Question 15

Which statement is needed for debt ratios?

Answer 15

Balance sheet - assets, liabilities + SE

Question 16

What statement(s) is needed for coverage or solvency ratios?

Answer 16

Need

1. Income Statement
   a. op income or EBIT
   b. interest expense
   c. fixed charges (lease oblig)
2. Balance Sheet
3. Statement of Cash flows
   
   • > for Free Cash Flow only

Question 17

What is the Fixed Charge Coverage ratio?

Answer 17

EBIT + Fixed Charges / (Fixed Charges + Interest Exp)

Question 18

What is the Free Cash Flow

Answer 18

This is a \$\$.  
   Cash from operations
-  Capital Expenditures
-  Cash Dividends
** measures how efficient a firm is in generating "free" cash.

Question 19

What is the Cash Flow to Fixed Charges ratio?

Answer 19

(Cash from ops + fixed charges + tax payments ) / Fixed Charges