Page 22 - Banking Finance October 2023

ARTICLE

manage their short-term debt payments and operational
needs. These ratios provide valuable insights into the
borrower's financial stability and capacity to handle financial
shocks.

Solvency Ratios:
Solvency ratios are financial metrics that assess a company's
long-term financial health and its ability to meet its long-
term debt obligations. Unlike liquidity ratios, which focus on
short-term obligations, solvency ratios provide insights into
a company's ability to cover its debts over the long term
and maintain a stable financial position. Here are some
important solvency ratios:
Debt-to-Equity Ratio: The debt-to-equity ratio measures A higher interest coverage ratio suggests that the company
the proportion of a company's financing that comes from has sufficient earnings to comfortably cover its interest
debt compared to equity. It indicates the extent to which a payments.
company is relying on borrowed funds to finance its
operations. Debt Service Coverage Ratio (DSCR): The debt service
coverage ratio is often used in project finance or lending for
Debt-to-Equity Ratio = Total Debt / Total Equity
capital-intensive projects. It evaluates a company's ability
to service its debt obligations, including both principal and
A lower debt-to-equity ratio is generally considered more
interest payments, from its operating cash flow.
favorable, as it suggests that the company has a greater
proportion of its financing coming from equity, which is DSCR = Operating Income / Total Debt Service
considered a more stable source of capital. If we disintegrate the formula further we can write the same
as
Debt-to Asset Ratio: The debt ratio (also known as the
DSCR = (Net Profit after Tax + Depreciation + Interest on
debt-to-assets ratio) shows the proportion of a company's
assets that are financed by debt. It indicates the company's Term Loan) / (Instalment of Term Loan + Interest on TL)
leverage or dependency on debt financing.
A DSCR greater than 1 indicates that the company is
Debt Ratio = Total Debt / Total Assets generating enough cash flow to cover its debt obligations.

A lower debt ratio indicates a lower risk of insolvency, as it Equity Ratio: The equity ratio (also known as the equity-to-
suggests that a larger portion of the company's assets is assets ratio) measures the proportion of a company's assets
financed by equity. that are financed by equity. It's a variation of the debt ratio
and provides insight into the company's financial stability.
Interest Coverage Ratio: The interest coverage ratio
Equity Ratio = Total Equity / Total Assets
measures a company's ability to cover its interest payments
with its earnings before interest and taxes (EBIT). It shows
A higher equity ratio indicates a more solid financial position,
whether a company is generating enough operating income as a larger portion of the company's assets is funded by
to meet its interest obligations.
equity.
Interest Coverage Ratio = EBIT / Interest Expenses
Solvency ratios are crucial for lenders, investors, and
Sometimes it is calculated as EBITDA/Interest expenses
creditors to assess a company's ability to meet its long-term
Where EBITDA stands for earnings before interest, taxes, financial commitments and to determine the risk of
depreciation and amoertization insolvency. These ratios help evaluate the company's capital

22 | 2023 | OCTOBER | BANKING FINANCE