World's most popular travel blog for travel bloggers.

“Describe various ratios that are likely to help management of a manufacturing company forming an opinion on the solvency position of business?

, ,

ANS (a) Solvency, or leverage, ratios, judge the ability of a company to raise capital and pay its obligations. Solvency ratios, which include debt to worth and working capital, determine whether an entity is able to pay all of its debts. In practice, bankers often include leverage ratios as debt covenants in contract agreements. Bankers want to ensure the entity can maintain operations during difficult financial periods.There are different types of solvency ratios that you can use to track different elements of your finances. Here are some of the most common types of solvency ratios that companies track on a regular basis:
Debt-to-Equity Ratio
This ratio is a measure of total debt as compared to shareholder equity. As an equation, you take your business’ total liabilities and divide them by your shareholders’ equity .Whereas a general high solvency ratio tends to indicate that a company is fiscally sound, a high debt-to-equity ratio suggests that the company over-utilized debt to bankroll its growth. As interest levels continue to climb, companies may suffer from volatile earnings. To prevent insolvency, business owners must focus on deferring costs, reducing debt and boosting overall profits. Another popular iteration of the ratio is the Debt to Equity ratio which uses only long-term debt in the numerator instead of total debt or total liabilities. Total debt includes both long-term debt and short-term debt which is made up of actual short-term debt that has actual short-term maturities and also the portion of long-term debt that has become short-term in the current period because it is now nearing maturity. This second classification of short-term debt is carved out of long-term debt and is reclassified as a current liability called current portion of long-term debt (or a similar name). The remaining long-term debt is used in the numerator of the long-term-debt-to-equity ratio.
FORMULA

Debt/Equity Ratio = Total Liabilities / Shareholders' Equity
Total Liabilities = Long Term Liability + Current liabilities
Shareholders Equity= Equity share capital + Preference share capital +                       Reserve&Surplus

Total-Debt-to-Total-Assets Ratio
This refers to the ratio of long-term and short-term liabilities compared to total holdings. As an equation, it is expressed as your business’ short- and long-term liabilities divided by its total assets. As a company’s total-debt-to-total-assets ratio increases, it poses a greater financial risk to banks and creditors.
When calculating total-debt-to-total-assets, it’s important to take into account the degree of leverage. While some liabilities, such as supplier costs and employee bonuses, may be negotiable, companies with high total-debt-to-total-assets have higher leverages and, as a result, lower flexibility. Because of this, businesses should strive to raise the value of current assets or reduce their debt levels moving forward.

Total-Debt-to-Total Assets Ratio =
TOTAL ASSETS = NON CURRENT ASSETS + CURRENT ASSETS
TOTAL DEBT = NON CURRENT LIABILITY + CURRENT LIABILITY

Interest-Coverage Ratios
The interest coverage ratio (ICR) is a measure of a company's ability to meet its interest payments. Interest coverage ratio is equal to earnings before interest and taxes (EBIT) for a time period, often one year, divided by interest expenses for the same time period. The interest coverage ratio is a measure of the number of times a company could make the interest payments on its debt with its EBIT. It determines how easily a company can pay interest expenses on outstanding debt.
Interest coverage ratio is also known as interest coverage, debt service ratio or debt service coverage ratio
Typically, a company with an interest-coverage ratio of 1.5 or less is viewed as financially unstable and may struggle to Secure loan from banks and other lenders. To boost your interest-coverage ratio, strive to reduce debt and boost overall profits.

FORMULA

INTEREST COVERAGE RATIO =
EBIT = EARNING BEFORE PAYMENT OF INTEREST ND TAX
INTEREST EXPENSE= INTEREST PAYMENT ON DEBENTURES + INTEREST PAYMENT IN LOANS TAKEN