Evaluate any business using financial ratios
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Solvency and leverage ratios measure how well a company is able to meet it’s long-term debt commitments. In this section, we cover the most important solvency ratios you need to know.
What are coverage ratios?
When you invest in companies or analyse them for others to invest in you need to be able to separate companies with a healthy and manageable amount of debt from companies that are overextending themselves.
Leverage from debt is very useful for businesses to finance their operations, but businesses that are too highly leveraged are at risk of not being able to cover their debts and may be forced to sell assets or, in extreme cases, declare bankruptcy,
Coverage ratios are a useful way that you can measure these risks to determine and decide whether a company has the ability to pay its existing debts.
List of coverage ratios
Below is the complete list of coverage ratios we have covered. Each will provide a detailed overview of the ratio, what it’s used for, and why.
They also explain the formula behind the ratio and provide examples and analysis to help you understand them.
- Asset Coverage RatioThe asset coverage ratio determines a company’s capacity to pay its debt through its assets.
- Cash Flow Coverage RatioThe cash flow coverage ratio represents the relationship between a company’s operating cash flow and its total debt.
- Cash Flow to Debt RatioThe cash flow to debt ratio is a coverage ratio that reflects the relationship between a company’s operational cash flow and its total debt.
- Debt Service Coverage RatioThe debt coverage ratio is used to determine whether or not a company can turn enough of a profit to cover all of its debt.
- Debt to Capital RatioThe debt to capital ratio is a ratio that indicates how leveraged a company is by dividing its interest-bearing debt with its total capital.
- Debt to Income Ratio (DTI)Debt to income (DTI) is a ratio measuring an individual’s ability to pay their debts.
- Fixed Charge Coverage RatioThe fixed-charge coverage ratio reflects a company’s capacity to pay for its fixed expenses, like debt, interest and lease.
- Interest Coverage RatioThe interest coverage ratio is both a debt ratio and a profitability ratio.
- Preferred Dividend Coverage RatioThe preferred dividend coverage ratio shows a company’s capacity to pay preferred shareholders their dividends, which are predetermined and fixed.