However, this ratio alone is not enough to determine whether a firm has too
much debt. Debt has the potential of being a low-cost solution to growth and
may provide an opportunity for a firm to expand. On the other hand, too
much debt will increase the fixed payments that a firm is subject to and will
likely increase the default risk.
The point here is that although the debt ratio can assist in understanding the
debt load of a firm, it may not be appropriate to draw a conclusion based on
this one ratio alone because debt has benefits and depends on the industry
that the firm belongs to.
The
solvency ratio
is also a ratio that is intended to measure a company’s
ability to pay its long-term obligations. This ratio shows an analyst how likely
a company will be able to meet its debt obligations. The solvency measure is
calculated as follows:
Solvency Measure= After Tax Net Profit+ Depreciation/ Long Term
Liabilities
+ Short Term Liabilities
Similar to the debt ratio, there is no ideal figure in terms of the solvency
ratio. The appropriate ratio level depends on the industry. However, you can
draw a general conclusion in that the lower a company’s solvency ratio, the
greater the probability that the company will default.

The following video takes a deeper look at solvency ratios:
Activity
Although there are many ratios that fall under this category, those that are
discussed here are some of the more common.
Receivables turnover
is
computed as sales divided by the accounts receivable.
This ratio shows how a firm is collecting on its receivables. Generally, it
would be preferred that this comes back higher because this would imply
that a firm is collecting on its receivables sooner. This ratio can be often
moved in response to credit policies that are extended to customers.
The
days' receivables
ratio
indicates how long, in days, a firm takes to
collect on its receivables. This is calculated as follows:
Days Receivables Ratio= 365/ Receivables Turnover
The next two ratios that are included in this lesson revolve around inventory.
The first is the
inventory turnover ratio
, which is calculated as follows:
Inventory Turnover Ratio= COGS (cost of goods sold)/Inventory
Given that the movement of inventory results in sales, a higher ratio can be
interpreted as better. The second ratio that involves inventory is the
days’
inventory ratio
, which indicates how long inventory sits before it is sold.
Although holding inventory is necessary to satisfy customers’ orders, this
comes at a cost. A firm would not want this figure to be too high because it
may imply unnecessary storage cost and may result in inventory that is
outdated. This ratio is calculated as follows:
Days Inventory Ratio= 365/Inventory Turnover
Efficiency

The three efficiency ratios that help in gauging a firm’s operating efficiency
are the following:
The total asset turnover
The fixed-asset turnover
The equity turnover
The
total asset turnover
measures a company’s ability to produce sales
given its investment in total assets. Those firms that are capital-intensive are

#### You've reached the end of your free preview.

Want to read all 107 pages?

- Spring '18
- Capital Asset Pricing Model, Financial Markets