What you’ll learn to do: Calculate ratios that analyze a company’s long-term debt-paying ability
Solvency analysis evaluates a company’s future financial stability by looking at its ability to pay its long-term debts.
Both investors and creditors are interested in the solvency of a company. Investors want to make sure the company is in a strong financial position and can continue to grow, generate profits, distribute dividends, and provide a return on investment. Creditors are concerned with being repaid and look to see that a company can generate sufficient revenues to cover both short and long-term obligations.
In this section, we’ll look at three common indicators of solvency:
- Debt to Equity
- Debt to Assets (and Equity to Assets)
- Times Interest Earned
These ratios that measure “leverage” are also called “gearing” ratios.