Solvency Ratios

Solvency refers to the firms ability to meet its long term indebtedness. Solvency ratio studies the firms ability to meet its long term obligations. The following are the important solvency ratios:

1. Debt-Equity Ratio

2. Proprietory Ratio

1. Debt Equity Ratio

This ratio helps to ascertain the soundness of the long term financial position of the concern. It indicates the proportion between total long term debt and shareholders funds. This also indicates the extent to which the firm depends upon outsiders for its existence. The ratio is calculated as:

Total long term debt includes Debentures, long term loans from banks and financial institutions. Shareholders funds includes Equity share capital, Preference share capital, Reserves and surplus.

Illustration : 

Calculate Debt Equity Ratio from the following information.

Rs.

Debentures                                                                                               2,00,000
Loan from Banks                                                                                     1,00,000
Equity share capital                                                                                1,25,000
Reserves                                                                                                       25,000

Solution:

2. Proprietory Ratio

This ratio shows the relationship between proprietors or shareholders funds and total tangible assets. The ratio is calculated as:

Illustration :

From the following calculate Proprietory Ratio

	Rs.		Rs.
Equity share capital	1,00,000	Furniture	10,000
Preference share capital	75,000	Bank	20,000
Reserves & surplus	25,000	Cash	25,000
Machinery	30,000	Stock	15,000
Goodwill	5,000

 

Solution :

 

(Note : All solvency ratios are expressed as a proportion.)