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Long-term solvency ratio based on equity coverage

Method of calculation

Formula for long term solvency ratio based on equity coverage: equity / fixed assets

Ratio's description

This ratio belongs to the group of ratios related to the horizontal analysis of the balance sheet. It indicates to what extent the equity covers company's fixed assets. It is the ratio that verifies the satisfaction of the golden balance rule, which says that fixed assets – being the long-term assets element with low liquidity level – should be covered by equity, which is a stable financing source available to the company for a long term. If the rule is satisfied, then the company's financial standing is good (in terms of long-term financial stability and solvency) and it strongly affects the positive assessment of the creditworthiness.

Ratio's interpretation

  • Ratio's values above 1 are interpreted as correct, indicating the satisfaction of golden balance rule and financial stability maintenance.
  • Ratio's values close to 1 are interpreted as a high risk of financial stability loss (financial imbalance).
  • Ratio's values below 1 are interpreted as incorrect, indicating that the golden balance rule is not satisfied and that the financial stability has been lost.
  • When assessing the changes in ratio's value over time (over few periods):
    • the increase of ratio's value is assessed positively, since it indicates an increase of financial stability,

       

    • the decrease of ratio's value is assessed negatively, since it indicates a decrease of financial stability.

       

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