The liquidity of a business firm is measured by its ability to pay its long term obligations, Die long term obligations include payments of principal amount on the due date and payments of interests on the regular basis. Long term solvency of any business can be calculated on the basis of the following ratios:
Debt-Equity Ratio: It depicts the relationship between the borrowed fund and owner’s funds. The lower the debt-equity ratio higher will be the degree of security to the lenders. A low debt-equity ratio implies that the company can easily meet its’long term obligations.
Debt-Equity Ratio = \(\frac {\textit{Long - term Debt}}{\textit{Equity/ Share holders Fund}}\)
Total Assets to Debt Ratio: It shows the relationship between the total assets and the long term loans A high Total Assets to Debt Ratio implies that more assets are financed by the owner’s fund and the company can easily meet its long-term obligations.
Total Assets to Debt Ratio = \(\frac {\textit{Total Assets}}{\textit{Long-term Debt}}\)
Interest Coverage Ratio: This ratio depicts the relationship between amount of profit utilise for paying interest and amount of interest payable. A high Interest Coverage Ratio implies that the company can easily meet all its interest obligations out of its profit.
Interest Coverage Ratio = \(\frac {\textit{Net profit before Interest and Tax}}{\textit{Interest on long-term Loans}}\)
Proprietary Ratio: It shows the relationship between the Shareholders Fund and the Total Assets. This ratio reveals the financial position of a business. The higher the ratio the higher will be the degree of safety for.the creditors. It is calculated as:
Proprietary Ratio= \(\frac {\textit{Share holders Fund}}{\textit{Total Assets}}\) or \(\frac {\textit{Equity}}{\textit{Total Assets}}\)
