1. Debt Equity Ratio: This ratio expresses the relationship between long-term debts and This ratio is usually expressed as a pure ratio, i.e., 1:1 or 2: 1. shareholder's funds. It indicates the proportion of funds which are acquired by long-term Debt = Long Term Borrowings + Long Term Provisions borrowings in comparison to shareholder's funds. This ratio is calculated to ascertain the Total Assets: Non-Current Assets (Tangible Assets + Intangible Assets + Non-Current soundness of the long-term financial policies of the firm Investments + Long Term Loans & Advances) + Current Assets Examples of Debts are Debentures, Mortgage Loan, Bank Loan, Loans from financial institutions and Public Deposits etc. Significance: This ratio expresses the relationship between long term debts and total assets. It measures the extent to which long term loans are covered by assets which indicates the margin of safety available to providers of long term debts. A lower debt to total assets ratio implies the use of lower debts in financing the assets which means a larger safety margin for lenders. On the other hand, higher ratio represents risky financial position as it implies the use of higher debts in financing the assets of the business.
Lang term Debts: These include "long term borrowings" and "Long term Provisions which 3. Proprietary Ratio: This ratio indicates the proportion of total assets funded by owners or shareholders. It is calculated as under :- mature after one year. For example, Debentures, Mortgage Loan, Bank Loan, Loan from financial institutions and Public Deposits etc. Share holder's Funds : include Share Capital and Reserve & Surplus Share Capital include Equity Share Capital and Preference Share Capital Reserve & Surplus Include Capital Reserve, Securities Premium, General Reserve and Balance in Statement of Profit & Loss Significance - This ratio is calculated to assess the ability of the firm to meet its long term liabilities. Generally, debt-equity ratio of 21 is considered safe. If the debt-equity ratio is more than that, it shows a rather risky financial position from the long-term point of view, as it indicates that more and more funds invested in the business are provided by long-term lenders. Proprietor's Funds or Shareholder's Funds/ Non Current Assets + Current Assets A high debt-equity ratio is a danger-signal for long-term lenders. Significance: A higher proprietary ratio is generally treated an indicator of sound financial The lower this ratio, the better it is for long-term lenders because they are more secure in that position from long-term point of view, because it means that a large proportion of total assets is case. Lower than 2: 1 debt equity ratio provides sufficient protection to long-term lenders provided by equity and hence the firm is less dependent on external sources of finance. On the contrary, a low proprietary ratio is a danger-signal for Long-term lenders as it indicates a lower 2. Debt to Total assets Ratio: This ratio is a variation of the debt-equity ratio and margin of safety available to them. The lower the ratio, the less secured are the long-term loans and they face the risk of losing their money. gives the same indication as the debt-equity ratio. In this ratio, long-term debts are expressed in relation to total assets. It is calculated as under :- 4. Interest Coverage Ratio: This ratio is also termed as 'Debt Service Ratio". This ratio is calculated by dividing the 'profit before charging interest and income-tax' by 'fixed interest charges.'
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the business will earn sufficient profits to pay the interest charges regularly. This ratio measures Profit before interest and income-tax is to be taken for the calculation of this ratio because this the margin of safety for long-term lenders. The higher the ratio, more secure the lender is in is the amount of profit out of which interest and income-tax is to be paid out. Fixed interest respect of payment of interest regularly. If profit just equals interest, it is an unsafe position for charges include interest on fixed (long-term) loans or debentures. the lender as well as for the company also, as nothing will be left for shareholders. An interest coverage ratio of 6 to 7 times is considered appropriate. It also indicates the extent Significance: This ratio indicates how many times the interest charges are covered by the to which profits can decline without in any way affecting the firm's ability to meet its fixed profits available to pay interest charges. A long-term lender is interested in finding out whether interest obligations.
PRACTICAL QUESTIONS Solvency Ratios Q. 23. Calculate the Debt Equity Ratio from the following:- Q. 26. Calculate Debt Equity Ratio from the following: Amount Total Assets 2,30,000; Total Debt 1,50,000; Current Liabilities 30,000. Equity Share Capital 3,00,000 [Ans. Debt Equity Ratio = Long term Debts /Shareholder's Funds 1.5:1] Preference Share Capital 50,000 Reserves 1,60,000 Q. 27. The debt-equity ratio of a company is 1: 2. Which of the following suggestions would Profit & Loss Balance (Accumulated Loss) (50,000) increase, decrease or not change it? Long-term Borrowings 2,00,000 Provision for Employee Benefits 60,000 1. Issue of Equity Shares [Ans. Debt Equity Ratio 0.57:1] 2. Cash Received from Trade Receivables Q. 24. From the following, ascertain Debt-Equity Ratio: 3. Sale of Goods on Cash Basis Amount 4. Repayment of Long term Borrowings Share Capital 6,00,000 5. Purchased Goods on Credit Capital Reserve 3,20,000 [Ans. (1) Decrease, (ii) No Change, (iii) No Change, (iv) Decrease, (v) NoChange] General Reserve 60,000 Profit & Loss Balance 1,40,000 Q. 28. Compute Debt to Total Assets Ratio from the following information: 8% Debentures 5,00,000 10% Long term Loan 3,40,000 Total Assets 35,00,000 Bills Payables 20,000 Long term Provision 1,12,000 Total Debts 32,00,000 Short-term Borrowings 1,00,000 Current Liabilities 2,20,000 Creditors 2,50,000 Outstanding Expenses 30,000 Current Assets 3,10,000 [Ans, Debt to Total Assets Ratio 0.8:1] [Ans. Debt Equity Ratio 0.85:11] Q. 25. Calculate Debt Equity Ratio from the following: Q. 29, Calculate Debt to Total Assets Ratio from the following information: Amount Tangible Fixed Assets 24,50,000 Intangible Fixed Assets 3,00,000 Shareholder's Funds 32,00,000 Total Debts 24,00,000 Current Assets 3,34,000 Reserve and Surplus 12,00,000 Trade Payables 5,60,000 Current Liabilities 84,000 Bank Overdraft 40,000 Lang term Borrowings 16,00,000 [Ans. 0.32:1] Long term Provisions 1,50,000 Hint. Reserve and Surplus will be ignored since it is already included in Shareholder's Funds [Am. Debt Equity Ratio 14:1] Hint: Shareholder's Funds : Non Current Assets + Wiring Capital-Non Current Liabilities 12,50,000
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Q. 30. From the following information, calculate Debt to Total Assets Ratio: Q. 35. From the following, ascertain Debt-Equity Ratio and Proprietary Ratie
8% Debentures 32,00,000 Share Capital 20,00,000 Equity Share Capital 20,00,000 Loan from (IDBI) 12,00,000 Loan from Bank 12,00,000 Reserve and Surplus 5,00,000 General Reserve 10,00,000 Current Liabilities 10,00,000 Short term Borrowings Surplus, i.e, Balance in Securities Premium 5,00,000 Fixed Assets 40,00,000 Statement of Profit &Loss 2,20,000 10% Debentures 3,00,000 Current Assets 20,00,000 [Ans, 0.54:1] [Ans.(i) Debt-Equity Ratio 0.43:1 (ii) Proprietary Ratio 58.33% Hint. Surplus i.e, Balance in Statement of Profit & Loss will be ignored since it is already Q. 36. Calculate the value of Current Assets of X Ltd. from the following information: included in Reserve and Surplus. Equity Share Capital 25,00,000 Profit & Loss Balance (2,00,000) Q. 31. Total Debt 40,00,000, Share Capital 15,00,000, Reserve and Surplus 8,00,000; Current 6% Preference Share Capital 5,00,000 Fixed Assets 30,00,000 Liabilities 5,00,000, Working Capital 7,00,000, Calculate Debt to Total Assets Ratio. General Reserve 8,00,000 Proprietary Ratio 0.75:1 [Ans currents assets 18,00,000] [Ans 0.56:1] Q. 37. From the following information, calculate interest coverage ratio and give your comments Q. 32. Calculate Debt to Total Assets Ratio from the following: also: Capital Employed 60,00,000 Trade Payables 8,00,000 Net Profit after Interest and Tax 1,20,000 Share Capital 20,00,000 Outstanding Expenses 40,000 Rate of Income Tax 50% Reserve and Surplus 16,00,000 15% Debentures 1,00,000 [Ans 0.35:1] 12% Mortgage Loan 1,00,000 Q33. Following particulars are extracted from the books of Bharat Rubber Lid: [Ans, Interest Coverage Ratio 9.89 times.] Comments: An interest coverage ratio of 6 to 7 times is considered appropriate. As the actual Share Capital 3,20,000 Non Current Assets 3,60,000 interest coverage ratio of this company is nearly 10 times, it means that the company will be General Reserve 1,00,000 Inventory 1,76,000 able to pay the interest on long-term loans regularly. Profit & Loss Balance 48,000 Trade Receivables 3,28,000 Q. 38. The following particulars are given to you: 9% Debentures 1,20,000 Cash & Cash equivalent 28,000 Current Liabilities 3,04,000 Share Capital 1,00,000 Tangible Fixed Assets 7,00,000 You are required to work out the following ratios Reserve and Surplus 1,50,000 Loans 10% 4,00,000 (i) Debt-Equity Ratio; (ii) Debt to Total Assets Ratio; (iii) Proprietary Ratio; (iv) Quick Ratio Current Liabilities 4,00,000 12% Debentures 2,00,000 [Ans. (i) Debt-Equity Ratio 0.26:1 (ii) Debt to Total Assets Ratio 0.13:1 (iii) Proprietary Ratio Current Assets 5,50,000 52.47% (iv) Quick Ratio 1.17:1] Net Profit for the year after interest and tax was 96,000. Rate of Income Tax was 50% Q. 34. Following particulars are given to you: Calculate (1) Debt Equity Ratio; () Proprietary Ratio; and (iii) Interest Coverage Ratio. Amount Also give your comments. Long term Borrowings 7,00,000 [Ans. (i) Debt-Equity Ratio 2.4:1 (ii) Proprietary Ratio 20% (iii) Interest Coverage Ratio4 times Long term Provisions 2,25,000 Comments: (i) Debt-Equity Ratio of the Company is not satisfactory because it is more than Non Current Assets 12,00,000 the acceptable norms of 2: 1. It shows risky financial position from the long-term point of view. Current Assets 5,40,000 Current Liabilities 1,40,000 (ii) Proprietary Ratio is only 20% which means that the long-term financial position of the Calculate (i) Debt Equity Ratio, (ii) Debt to Total Assets Ratio and (iii) Proprietary Ratio. Company is not satisfactory because only 20% of the total assets of the company are funded by [Ans. (i) 1.37:1, (ii) 0.53: 1, (iii) 38.79%) equity.(iii) Normally acceptable interest-coverage ratio is 6 or 7 times, whereas the actual ratio for this company is 4. It means that the company may face difficulty in paying the interest on long-term loans regularly in case of fall of profits.
