7.Chapter 4 Ratio Analysis: Solvency Ratios :Proprietary Ratio,Total Assets to Debt Ratio,Interest Coverage Ratio

Dear Analysts,

Welcome to the class. Today we will cover all the remaining Solvency Ratios which are:

Proprietary Ratio
Total Assets to Debt Ratio
Interest Coverage Ratio


Learning Objectives:

To know the Formulas
To understand its Significance

1. Proprietary ratio..

 expresses relationship of shareholders' funds (proprietors' funds )to total assets and
 is calculated as follows..
= shareholders' funds divided by total assets 

Significance.. higher proportion of shareholders funds in financing the total asset is a positive feature as it provides security to creditors.

Ques 1  (Example)

From the following balances obtained from the books of Hira limited.. calculate proprietary ratio..
plant and machinery                     1000000
land and building                            600000
motor car                                         800000
furniture                                          150000
inventory                                         450000
trade receivables                              90,000
Cash at bank                                   340000
non current liabilities                    1000000

current liability                               620000

Ans.
Proprietary ratio =shareholders funds/ total assets
Total assets = non current assets + current assets 
=( plant and machinery + land and building + motor car+ furniture) + (inventories + trade receivables + cash at Bank)
= (10 lakh + 600000 + 800000 + 150000) + (450000 + 90000 + 340000) = 3430000
Total assets =( equity + liabilities)= shareholders funds + non current liabilities plus current liabilities 
Therefore, shareholders fund =Total Assets - non current liabilities - current liabilities
=3430000 - 10 lakh - 620000 
= 1810000
Therefore, proprietary ratio = 1810000 /3430000 = 0.527

2. Total Assets to Debt Ratio..

this ratio measures the extent of the coverage of long-term debts by assets. It is calculated as
= Total assets divided by Long Term Debts

Significance.. this ratio primary indicates the rate of external funds in financing total assets and the extent of coverage of long term debts by assets. 

The higher ratio indicates that assets have been mainly financed by owners' funds and long term loans is adequately covered by assets.

Ques 1  (Example)

Calculate Total assets to debt ratio from the following information:
Equity share capital                                                         400000
Long term borrowings                                                     180000
Surplus i.e in balance in statement of profit and loss      100000
General reserve                                                                70,000
Current liabilities                                                             30,000
Long term provisions                                                      120000

Ans.
Total assets to Debt ratio = Total assets/ long-term debts
Total assets = (equity and liabilities) = share holders funds + non current liabilities + current liabilities 

= (equity share capital + surplus i.e. balance in statement of profit and loss + general reserve) + (long term borrowings + long term provisions ) + current liabilities
= (4 lakh + one lakh + 70000 )+ (180000 + 120000) + 30000 = 9 lakh
= long term debt = long term borrowings + long term provisions
= 180000 +120000 = 300000
Therefore, total asset to debt ratio

= 9 lakh /3 lakh = 3 :1

4. Interest Coverage Ratio

it is a ratio of which deals with the servicing of interest on long term debts. It is a measure of security of interest payable on long term debts.
It expresses the relationship between profits available for payment of interest and the amount of interest payable. 

Interest coverage ratio = net profit before interest and tax / interest on long term debts

Significance..It reveals the number of times interest on long term debts is covered by the profits available for payment of interest. A higher interest coverage ratio ensure safety of interest on debts

Ques 1   (Example)
From the following details calculate interest coverage ratio ..
net profit after tax                      60000
15% long-term debt               1000000
and tax rate                                  40%

Ans.

Net profit after tax = Rs 60000, tax rate = 40% 

Net profit before tax =     net profit after tax       

                                         _______________      x 100

                                          (100 - tax rate )

= 60000 x 100 

   ___________

         100 - 40 

= 1 lakh
interest on long term debt = 15% of 10 lakh = 150000
therefore, net profit before interest and tax = net profit before tax + interest on long term debts
= 1 lakh + 150000 = 250000
Thus, interest coverage ratio = net profit before interest and tax /interest on long term debt 

= 250000 / 150000 

=1.67 times