Solvency ratios

Solvency Ratios

Financial metrics that measure a company’s long-term financial stability and ability to meet long-term obligations, focusing on capital structure and debt management.

For example, key solvency ratios include:

• Debt-to-equity ratio (total debt ÷ shareholders’ equity): A manufacturer with 0.8 has $0.80 of debt for every $1 of equity, indicating conservative financial leverage
• Debt-to-assets ratio (total debt ÷ total assets): A retailer with 0.35 finances 35% of its assets with debt, suggesting moderate leverage
• Interest coverage ratio (EBIT ÷ interest expense): A service company with 6.0 generates operating earnings six times its interest obligations, indicating strong debt-servicing ability
• Fixed charge coverage ratio ((EBIT + fixed charges) ÷ (fixed charges + interest)): A transportation company with 2.5 generates sufficient earnings to cover fixed obligations 2.5 times

Solvency ratios help stakeholders assess financial risk and long-term viability. They indicate the proportion of operations financed through debt versus equity and the ability to meet fixed financial commitments. Lower leverage ratios generally suggest greater financial stability and flexibility, while higher coverage ratios indicate stronger debt-servicing capacity. These metrics are particularly important during economic downturns or when companies face industry challenges that might strain their ability to meet long-term obligations.