– Solvency measures the amount of debt and other expense obligations used in the farm business relative to the amount of owner equity invested in the business.
– Solvency ratios provide an indication of the business’s ability to repay all financial obligations if all assets were sold, as well as an indication of the ability to continue operations as a viable farm business after a financial adversity, such as a drought.
The following are major ratios for solvency analysis.
a) Debt to Asset Ratio:
– The debt-asset ratio, sometimes just called the debt ratio, measures the relative proportions of debt and equity funds used to finance the firm’s assets and is defined as:
Total debt to asset ratio = Total debt (liabilities)/ Total asset
Decision criteria:
|
Strong |
Stable |
Weak |
|
< 30% |
30-70 % |
>70% |
b) Debt to Equity Ratio:
– Debt to equity ratio (a.k.a. debt-equity ratio) indicates the relative use of debt and equity as source of capital to finance the company’s assets, evaluated using book values of the capital sources
Total debt to equity ratio =Total debt (liabilities)/ Total shareholders ′ equity
Decision Criteria:
|
Strong |
Stable |
Weak |
|
< 42% |
42-230% |
>230% |
c) Equity to Asset Ratio:
Total equity to asset ratio =Total Equity/ Total Asset
Decision Criteria
|
Strong |
Stable |
Weak |
|
>70% |
30-70% |
<30% |
