Long Term Liquidity Ratios/ Solvency Ratios

Solvency refers to the business’ long-term financial position. Solvency ratios are a key component of financial analysis and are used to measure a company’s ability to pay long-term debts. 

These ratios help the investors to understand the ability of the business to meet its long-term liabilities and help them in decision making for long-term investment of their funds in the business.

Although these ratios vary according to the nature of the industry but a solvency ratio of 0.5 is considered to be an ideal measure.


The various types of solvency ratios are –


The debt to equity ratio is used to measure the firm’s obligations to creditors in relation to the funds invested by owners. It is calculated by dividing a company’s total liabilities with the shareholder’s equity.

Debt to Equity Ratio = Long Term Debt/ Shareholders Funds

Here Long-Term Debt includes long-term loans, i.e., Debentures or Long-term loans taken from Financial Institutions and Equity means Shareholders’ Funds, i.e., Equity Share Capital, Preference Share Capital and Reserves in the form of Retained Earnings.


Debt ratio is used to measure a company’s financial leverage. It is the ratio of total debt (long-term liabilities) and total assets (the sum of current assets, fixed assets, and other assets such as ‘goodwill’). It is calculated as –

  Debt Ratio = Long Term Debt / Total Assets

 A low Debt ratio indicates the stable financial position of the business whereas a higher Debt Ratio represents that the company is riskier.


Also known as Equity ratio , this ratio establishes the relationship between Shareholders’ funds and total assets of the business. It is calculated as –

Proprietary Ratio = Shareholder’s Funds/ Total Assets

The higher the ratio, the less will be the financial risk on the part of the business.


The interest coverage ratio (ICR) is a measure of a company’s ability to meet its interest payments.

It is represented as

Interest Coverage Ratio = EBIT (Earnings before interest and tax) / Interest on long term debt

A high interest coverage ratio indicates favourable solvency position of the firm whereas a low ratio indicates debt burden on the business.


Thus, the solvency ratios are the ratios that determine the solvency of a business organisation by measuring its ability to pay long term debt obligations and form an important aspect of analysing a company’s long-term financial health and stability.

Accounting & Finance for Banking

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