Q10RQ - Horngren'S Financial And Managerial Accounting

Question

Briefly describe the ratios that can be used to evaluate a company’s ability to pay long-term debt.

Step-by-Step Solution

Answer

Debt ratio, 

Debt to Equity ratio, 

Times Interest Earned ratio etc. 

Step 1:Meaning of Ratio

The ratio describes the link between the two things and shows the relation and effect of one on another.

Step 2: Explanation of some ratios used by the companies to evaluate their ability to pay long-term debt

1. The debt ratio shows the relation between the company's assets and debts and indicates how much of the assets are financed by the debt.

Formula:

$\text{Debt} \text{ratio}=\frac{\text{Total} \text{Liabilities}}{\text{Total} \text{Assets}}$

2. Debt equityratio shows the relation between the amounts and how much of the capital employed is divided among the company's owners or creditors.

Formula;

$\text{Debt - Equity} \text{ratio}=\frac{\text{Total} \text{Liabilities}}{\text{Total} \text{equity}}$

3. The times-Interest-Earned ratio indicates the business's ability to pay interest expenses or debt obligations.

Formula:

$\text{Times} \text{interest} \text{earned} \text{ratio}=\frac{\text{Earnings} \text{before} \text{interest} \text{and} \text{tax}}{\text{Interest} \text{expense}}$