Question

A small family business got a total assets of $35,950 and a total debt of $11,250, Calculate, and explain what each of the following means to the owner/manager.

a. The business Solvency ratio.

b. Its Debt/Asset ratio.

c. Its Debt/Equity ratio.

Answer 1

Answer : Calculation of business Solvency ratio.

1. Debt/Asset ratio = Total Debt / Total assets

= $11,250 /  $35,950

= 0.31

Interpretation :

• This ratio quantifies the percentage of a company's assets that have been financed with debt. A higher ratio indicates a greater degree of leverage, and consequently, financial risk.
• Here the ratio is 0.31 it means lower degree of the company's leverage .

2. Debt/Equity ratio = Total Debt / Total Equity

Total Equity = Total assets - Total Debt

= $35,950 -  $11,250

= $24,700

Debt/Equity ratio =  $11,250 / $24,700

= 0.46

Interpretation :

• This ratio indicates the degree of financial leverage being used by the business and includes both short-term and long-term debt
• A rising debt-to-equity ratio implies higher interest expenses.
• Here, the ratio is 0.46, means the interest burden on company is on limit.