Solvency Ratios

Concept

Long-Term Financial Health

Solvency ratios measure ability to meet long-term obligations. Debt-to-Equity = Total Liabilities / Total Equity. Debt Ratio = Total Liabilities / Total Assets. Times Interest Earned (TIE) = EBIT / Interest Expense — measures how many times earnings can cover interest payments.

Example

Evaluating Solvency

Total Liabilities: $300,000 | Total Equity: $200,000 | Total Assets: $500,000 EBIT: $75,000 | Interest Expense: $15,000 Debt-to-Equity = $300K / $200K = 1.5 Debt Ratio = $300K / $500K = 0.60 (60%) TIE = $75K / $15K = 5.0 times A TIE of 5.0 means earnings cover interest 5 times over — generally comfortable.

Key Point

Leverage Trade-off

Higher leverage (more debt) amplifies both returns and risk. A company with high debt-to-equity may generate higher ROE but faces greater bankruptcy risk during downturns.

Profitability Ratios

Efficiency Ratios

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Practice questions from this module to reinforce what you learned.

Practice Questions