Solvency ratios measure a company’s ability to pay off its long-term obligations such as bank loans, bonds payable, etc. Better solvency ratios indicate a more creditworthy and financially sound company in the long-term. Shareholder’s Funds (Owner’s Equity) portion out of the total liabilities determines the Solvency of a company.

## Types of Solvency Ratios

Conmanly used Solvency Ratios are

1. Debt to Equity
2. Debt to Assets
3. Times Interest Earned
4. Debt to Capital

### Debt to Equity

It is defined as the ratio of company’s total liabilities divided by it’s total assets. Higher ratio implies more obligations both short and long term a company has.

Debt to Equity = Total Liabilities / Shareholders Equity

Both total liabilities and shareholders equity figures can be obtained from balance sheet. Other variation of above formula uses only the interest bearing long-term liabilities in the numerator.

### Debt to Assets

It measures debt of a company as a percentage of its total assets. It is defined as the ratio of total debt of a company divided by its total assets.

Debt to Assets = Total Debt / Total Assets

Total debt equals long-term debt and short-term debt. It is equivalent to total liabilities minus non-debt liabilities such as accounts payable, salaries payable, etc. Total assets include both current assets and non-current assets.

### Times Interest Earned

It measures if a company has earned enough profits to make its interest payments. It is defined as the EBIT (Earnings before Interest and Tax) divided interest expense.

Times Interest Earned = Earnings before Interest and Tax / Interest Expense

A higher times interest earned ratio indicates that the company’s interest expense is low relative to its EBIT which indicates better long-term financial strength, and vice versa.

### Debt to Capital

It measures how much of the capital employed is debt. It is defined as ratio of interest-bearing debt to the sum of interest-bearing debt and shareholders equity.

Debt to Capital = Interest bearing Debt / (Interest bearing Debt + Shareholders Equity)

Interest bearing debt includes bonds payable, bank loans, notes payable, etc. Non-interest bearing debt includes trade payable, accrued expenses, etc.

Solvency ratio