The Tale of Two Companies: A Deep Dive into Solvency Ratios

In the financial hub of Financia, two companies—SteadySteel Ltd. and RiskyMetals Inc.—were leading manufacturers in the steel industry. Both were looking to expand their operations by taking loans from a major bank. However, the bank needed to assess their long-term financial stability before making a decision.

To do this, the bank’s analysts examined solvency ratios, which measure a company's ability to meet long-term financial obligations and avoid bankruptcy. Let’s take a closer look at these ratios and how they influenced the final decision.

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1️⃣ Debt-to-Equity (D/E) Ratio – How Much Debt vs. Equity?

$$\text{Debt-to-Equity Ratio} = \frac{\text{Total Debt}}{\text{Total Equity}}$$

• This ratio measures the proportion of debt used to finance a company’s assets relative to shareholder equity. A lower ratio indicates a healthier balance between debt and equity.

📌 SteadySteel Ltd.:

• Total Debt = ₹80 crore
• Total Equity = ₹100 crore
• D/E Ratio = 0.8

📌 RiskyMetals Inc.:

• Total Debt = ₹350 crore
• Total Equity = ₹100 crore
• D/E Ratio = 3.5

🔍 Analysis:

• SteadySteel Ltd. has a balanced capital structure with a mix of debt and equity.
• RiskyMetals Inc. is heavily dependent on borrowed funds, increasing its financial risk.

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2️⃣ Interest Coverage Ratio – Can the Company Afford Its Interest Payments?

$$\text{Interest Coverage Ratio} = \frac{\text{EBIT (Earnings Before Interest and Taxes)}}{\text{Interest Expense}}$$

• This ratio measures how many times a company can cover its interest expenses using its operating earnings. A higher ratio means a stronger ability to pay interest.

📌 SteadySteel Ltd.:

• EBIT = ₹62 crore
• Interest Expense = ₹10 crore
• Interest Coverage Ratio = 6.2

📌 RiskyMetals Inc.:

• EBIT = ₹52 crore
• Interest Expense = ₹40 crore
• Interest Coverage Ratio = 1.3

🔍 Analysis:

• SteadySteel Ltd. comfortably covers its interest payments.
• RiskyMetals Inc. is barely covering its interest, leaving little room for financial flexibility.

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3️⃣ Equity Ratio – How Much of the Business is Funded by Owners?

$$\text{Equity Ratio} = \frac{\text{Total Equity}}{\text{Total Assets}}$$

• This ratio shows what portion of a company's assets are financed by shareholders' equity rather than debt. A higher ratio indicates stronger financial stability.

📌 SteadySteel Ltd.:

• Total Equity = ₹100 crore
• Total Assets = ₹200 crore
• Equity Ratio = 50%

📌 RiskyMetals Inc.:

• Total Equity = ₹100 crore
• Total Assets = ₹650 crore
• Equity Ratio = 15%

🔍 Analysis:

• SteadySteel Ltd. is well-capitalized and less dependent on debt.
• RiskyMetals Inc. is overwhelmingly financed by debt, making it vulnerable in tough times.

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4️⃣ Debt-to-Asset Ratio – How Much of the Assets Are Financed by Debt?

$$\text{Debt-to-Asset Ratio} = \frac{\text{Total Debt}}{\text{Total Assets}}$$

• This ratio measures what percentage of a company’s assets are financed by debt. A higher ratio suggests greater financial leverage and risk.

📌 SteadySteel Ltd.:

• Debt-to-Asset Ratio = 40%

📌 RiskyMetals Inc.:

• Debt-to-Asset Ratio = 85%

🔍 Analysis:

• SteadySteel Ltd. has a conservative debt strategy.
• RiskyMetals Inc. relies too much on debt, making it highly susceptible to financial distress.

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Final Verdict: Who Gets the Loan?

After analyzing these solvency ratios, the bank approved SteadySteel Ltd.'s expansion loan with a lower interest rate, as it showed strong financial health. RiskyMetals Inc., on the other hand, was denied, as its high reliance on debt and low financial cushion made it too risky.

📢 Key Takeaway:
Solvency ratios are critical indicators of long-term financial stability. A company that balances debt and equity wisely is more likely to survive economic downturns, secure funding, and grow sustainably.

[Finance]