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101 Concepts for the Level I Exam

Concept 57: Leverage and Coverage Ratios

Solvency refers to a company’s ability to meet its long-term debt obligations. In evaluating solvency:

  • Leverage ratios focus on the balance sheet and measure the amount of debt financing relative to equity financing.
Leverage Ratio Numerator Denominator
Debt to assets Total debt Total assets
Debt to capital Total debt Total debt + shareholder’s equity
Debt to equity Total debt Total shareholder’s equity
Financial leverage Average total assets Average total equity
  • Coverage ratios focus on the income statement and cash flows and measure the ability of a company to cover its interest payments.
Coverage Ratio Numerator Denominator
Interest coverage EBIT Interest payments
Fixed charge coverage EBIT + Lease payments Interest payments +lease payments

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