Guidance portal

World of Guidance and Education

Long Term Solvency (Liquidity) Ratios. (Definition)

As the name suggests long term solvency ratios (also known as leverage ratios) are used to obtain

information about the company’s ability to meet its long term obligations as and when fall due. In other words ability to settle obligations that fall due after 12 months or longer period, therefore these ratios focus on long term loan and interest paying ability of the company.

Types of Long Term Solvency (Liquidity) Ratios

To check the ability of the company of meeting its long term obligations following ratios are used.

  • Interest Coverage Ratio
  • Debt / Equity Ratio

Following pages will explain the listed above ratios using the written below method:

FORMULA (Long Term Solvency (Liquidity) Ratios)

First question comes in mind is HOW TO CALCULATE THE PARTICULAR RATIO? I will write down the most common formula used for calculating a ratio along with alternative, if any.

 

EXAMPLE (Long Term Solvency (Liquidity) Ratios)

With example I will calculate the ratio using the formula given above. PLEASE NOTE THAT, in examples I will use data from HYPOTHETICAL FINANCIAL STATEMENTS (as given here)so that you can calculate ratios from real financial statements in you practical life.

 

MEASUREMENT UNIT (Long Term Solvency (Liquidity) Ratios)

In which unit the ratio is measured i.e. in currency unit (dollars), percentages, days or whatever.

INTERPRETATION (Long Term Solvency (Liquidity) Ratios)

After calculating the ratio, the next logical question that comes in mind is WHAT DOES THIS RATIO MEAN? So I will teach

  • How to interpret the ratio; and
  • What particular user needs this ratio addresses. (You must have an understanding of users’ needs of financial statements; please refer the topic 1- financial statement users for details).

 

comments powered by Disqus