Practicing Success
Long term solvency is indicated by: |
Current Ratio Quick Ratio Net Profit Ratio Debt/Equity Ratio |
Debt/Equity Ratio |
The correct answer is option 4- Debt/Equity Ratio. The persons who have advanced money to the business on long-term basis are interested in safety of their periodic payment of interest as well as the repayment of principal amount at the end of the loan period. Solvency ratios are calculated to determine the ability of the business to service its debt in the long run. Debt-Equity Ratio measures the relationship between long-term debt and equity. If debt component of the total long-term funds employed is small, outsiders feel more secure. From security point of view, capital structure with less debt and more equity is considered favourable as it reduces the chances of bankruptcy. Normally, it is considered to be safe if debt equity ratio is 2:1. |