Accounting & auditingLesson 3 of 3 in the course Measures of Financial Health

Solvency Ratios: Leverage and Interest Coverage

5 flashcards · 5 quiz questions · 5 match pairs · 4 fill-in sentences · English

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Summary

Solvency analysis helps determine whether a company can meet its long-term obligations and remain in business. This lesson introduces two related ratios that show how a company finances its assets: the debt-to-assets ratio and the debt-to-equity ratio.

The debt-to-assets ratio measures the proportion of a company's assets financed by debt. For this calculation, debt includes current liabilities and long-term liabilities.

All flashcards

What does the debt-to-assets ratio indicate?
The proportion of a company's total assets financed by its liabilities.
How is the debt-to-assets ratio calculated?
Divide total current and long-term liabilities by total assets.
What does a debt-to-equity ratio of 1.5:1 mean?
The company has $1.50 of liabilities for each $1 of stockholders' equity.
What does the times interest earned ratio assess?
How many times earnings before interest and taxes cover interest expense.
What does the times interest earned ratio not measure?
Whether a company can repay the principal amount of its debt.

Quiz questions

  1. Why should analysts consider industry data and prior periods when interpreting a solvency ratio?Answer: They provide context for judging what the ratio may indicate about the company.
  2. All else being equal, what does a higher debt-to-assets ratio generally suggest?Answer: Greater reliance on liabilities to finance assets and potentially greater financial risk.
  3. A company has total liabilities of $180,000 and stockholders' equity of $120,000. What is its debt-to-equity ratio?Answer: 1.5:1, or $1.50 of liabilities per $1 of equity.
  4. A company reports EBIT of $60,000 and interest expense of $10,000. What is its times interest earned ratio?Answer: 6 times.
  5. Why might lenders consider a company's times interest earned ratio?Answer: It helps assess the company's ability to cover interest charges from earnings.

Based on Principles of Finance by Julie Dahlquist, Rainford Knight (OpenStax), licensed CC BY 4.0. Adapted into a summary, flashcards and quizzes.

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