IS Debt to Equity ratio of a tree. 0.8; Delet
is Rs 4,50.000 and proprietary Ratio is 0.45
; What are
liabilities?
its Current
Answers
Answer:
Yes I know this see below
Explanation:
A company usually does not only run on owner’s fund. Most companies have a debt factor, whether it is loans, deposits, debentures etc. So a check has to be kept on the cost of such debt and whether the company is capable of meeting such costs. This is where solvency ratios are useful.
1] Debt to Equity Ratio
The debt to equity ratio measures the relationship between long-term debt of a firm and its total equity. Since both these figures are obtained from the balance sheet itself, this is a balance sheet ratio. Let us take a look at the formula.
Debt to Equity Ratio =
Long-Term Debt
Shareholders Funds
Lond Term Debt = Debentures + Long Term Loans
Shareholders Funds = Equity Share Capital + Preference Share Capital + Reserves – Fictitious Assets
The debt-equity ratio holds a lot of significance. Firstly it is a great way for the company to measure its leverage or indebtedness. A low ratio means the firm is more financially secure, but it also means that the equity is diluted.
In contrast, a high ratio indicates a risky business where there are more creditors of the firm than there are investors. In fact, a high debt to equity ratio may deter more investors from investing in the firm, and even deter creditors from lending money.
While there is no industry standard as such it is best to keep this ratio as low as possible. The maximum a company should maintain is the ratio of 2:1, i.e. twice the amount of debt to equity.
Browse more Topics under Accounting Ratios
Meaning, Objectives, Advantages and Limitations of Ratio Analysis
Types of Ratios
Liquidity Ratios
Activity (or turnover) Ratios
Profitability Ratios
2] Debt Ratio
Next, we learn about debt ratio. This ratio measures the long-term debt of a firm in comparison to its total capital employed. Alternatively, instead of capital employed, we can use net fixed assets. So the debt ratio will measure the liabilities (long-term) of a firm as a percent of its long-term assets. The formula is as follows,
Debt Ratio =
Long-Term Debt
Capital Employed
OR
Long-Term Debt
Net Assets
Capital Employed = Long Term Debt + Shareholders Funds
Net Assets = Non-Fictitious Assets – Current Liabilities
This is one of the more important solvency ratios. It indicates the financial leverage of the firm. A low ratio points to a more financially stable business, better for the creditors. A higher ratio points to doubts about the firms long-term financial stability. But a higher ratio helps the management with trading on equity, i.e. earn more income for the shareholders. Again there is no industry standard for this ratio.
3] Proprietary Ratio
The third of the solvency ratios is the proprietary ratio or equity ratio. It expresses the relationship between the proprietor’s funds, i.e. the funds of all the shareholders and the capital employed or the net assets. Like the debt ratio shows us the comparison between debt and capital, this ratio shows the comparison between owners funds and total capital or net assets. The ratio is as follows,
Proprietary Ratio =
Shareholders Funds
Capital Employed
OR
Shareholders Funds
Net Assets
A high ratio is a good indication of the financial health of the firm. It means that a larger portion of the total capital comes from equity. Or that a larger portion of net assets is financed by equity rather than debt. One point to note, that when both ratios are calculated with the same denominator, the sum of debt ratio and the proprietary ratio will be 1.
4] Interest Coverage Ratio
All debt has a cost, which we normally term as an interest. Debentures, loans, deposits etc all have an interest cost. This ratio will measure the security of this interest payable on long-term debt. It is the ratio between the profits of a firm available and the interest payable on debt instruments. The formula is,
Interest Coverage Ratio =
Net Profit before Interest and Tax
Interest on Long-Term Debt
Solved Examples for You
Q: Calculate Interest Coverage ratio from the following details
NPAT is 97,500
Tax Rate is 35%
Debentures are 6,00,000 at 10%
Solution:
NPAT = 1,25,000
Tax Rate = 35%
Net Profit before tax = (97500 × 100) ÷ 65
Net Profit Before tax = 1,50,000
Debentures Interest = 6,00,000 × 10% = 60,000
Interest Coverage Ratio =
Net Profit before Interest and Tax
Interest on Long-Term Debt
=
150000
60000
Interest Coverage Ratio = 2.5:1
So in the current earnings before interest and tax, the firm can cover the interest cost for 2.5 times.
Peace out.!
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