AccountancyCBSE Class 12 · Accounting Ratios

Solvency Ratios Class 12: Debt-Equity, Proprietary and Interest Coverage Ratios

Updated 15 October 2026 · Fact-checked

Solvency ratios show a firm's ability to meet its long-term obligations. The syllabus covers debt-equity ratio (long-term debt ÷ shareholders' funds), debt to capital employed, total assets to debt, proprietary ratio (shareholders' funds ÷ total assets) and interest coverage ratio (profit before interest and tax ÷ interest on long-term debt).

Capital employed is equity plus long-term debt; each solvency ratio compares debt, equity, assets or profit with these parts.

Illustration drawn for QuestionBuddy.

Understand Solvency Ratios

Purpose. Long-term lenders and debenture holders want to know whether the firm can pay interest regularly and repay principal. Solvency ratios compare borrowed funds with owners' funds and assets, and profit with interest.

Definitions used.

Long-term debt = long-term borrowings + long-term provisions (non-current liabilities).
Shareholders' funds (equity) = share capital + reserves and surplus (a debit balance of profit and loss reduces it).
Capital employed = shareholders' funds + long-term debt = total assets − current liabilities.

1. Debt-Equity Ratio = Long-term Debt ÷ Shareholders' Funds. About 2 : 1 is often accepted as a safe upper limit; a lower ratio means more owners' money and more safety for lenders.

2. Debt to Capital Employed Ratio = Long-term Debt ÷ Capital Employed. Shows what share of long-term funds is borrowed.

3. Total Assets to Debt Ratio = Total Assets ÷ Long-term Debt. Higher means more asset cover for lenders.

4. Proprietary Ratio = Shareholders' Funds ÷ Total Assets. Shows the proportion of assets financed by owners; higher means stronger long-term position.

5. Interest Coverage Ratio = Net Profit before Interest and Tax ÷ Interest on Long-term Debt. How many times interest is covered by profits; higher means interest is safer. If profit after tax is given, add back tax and interest.

Effect of transactions on debt-equity (favourite MCQ).

Issue of equity shares for cash: equity up → ratio falls.
Issue of debentures or long-term loan: debt up → ratio rises.
Redemption of debentures in cash: debt down → ratio falls.
Issue of bonus shares from reserves: equity unchanged → no change.
Transactions only in current assets or current liabilities: no change.

Solvency Ratios: key facts

Debt-equity ratio: Long-term debt ÷ Shareholders' funds
Debt to capital employed: Long-term debt ÷ (Shareholders' funds + Long-term debt); Capital employed = total assets − current liabilities.
Total assets to debt: Total assets ÷ Long-term debt
Proprietary ratio: Shareholders' funds ÷ Total assets
Interest coverage ratio: Net profit before interest and tax ÷ Interest on long-term debt; PBIT = PAT + tax + interest.

How to answer Solvency Ratios questions

First rebuild the three building blocks (long-term debt, shareholders' funds, total assets), then every solvency ratio is one division.

1Shareholders' funds = share capital + reserves and surplus (subtract a debit balance of profit and loss).
2Long-term debt = long-term borrowings + long-term provisions.
3Total assets from the balance sheet total; capital employed = total assets − current liabilities.
4Compute the ratio asked; express debt-equity, proprietary and total assets to debt as x : 1.
5For interest coverage, build PBIT from PAT by adding tax and interest.
6For transaction effects, change debt or equity and recompute.

Solvency Ratios in real life

The idea, met in an everyday situation. Answer the question in your own words, then compare with the model answer. The one-line hook is what to remember.

Debt-equity and risk

Suppose two cafés each have ₹10,00,000 of long-term funds. Café A's owners put in ₹2,00,000 and borrowed ₹8,00,000; Café B's owners put in ₹8,00,000 and borrowed ₹2,00,000. A bank is asked for a further loan by both.

Calculate each café's debt-equity ratio and say which one the bank should consider riskier.

Try it first, then show the solutionSolution

Café A: 8,00,000 ÷ 2,00,000 = 4 : 1.
Café B: 2,00,000 ÷ 8,00,000 = 0.25 : 1.
Café A must pay interest on much more debt from the same business.

Answer: Café A (4 : 1) is far riskier than Café B (0.25 : 1). With little owners' money as a cushion, a bad year could leave Café A unable to pay interest, so the bank would be cautious.

Memory hook: The more the business is borrowed, the thinner the cushion.

Tricks to remember Solvency Ratios

Short memory aids. Say each one aloud once, then use it on a question the same day.

D over E; E over A
Debt-equity = Debt ÷ Equity; Proprietary = Equity ÷ Assets.
Use it when: Not mixing the two.
Add back the two Ts
PBIT = PAT + Tax + inTerest.
Use it when: Interest coverage.
Bonus changes nothing
Bonus shares move reserves into capital: equity unchanged, ratio unchanged.
Use it when: Effect-of-transaction MCQs.

Solvency Ratios: solved examples

Ordered from board level to HOTS. Try each one before you open the solution.

Example 1: Debt-equity ratio · 1 mark · MCQBoard level

Long-term debt is ₹3,00,000 and shareholders' funds are ₹6,00,000. The debt-equity ratio is:
(a) 2 : 1
(b) 0.5 : 1
(c) 0.33 : 1
(d) 1.5 : 1

Try it first, then show the solutionSolution

3,00,000 ÷ 6,00,000 = 0.5.

Answer: (b) 0.5 : 1

Example 2: Four ratios from one balance sheet · 4 marks · Short answerBoard level

Share capital ₹5,00,000; reserves and surplus ₹1,00,000; long-term borrowings ₹2,40,000; long-term provisions ₹60,000; current liabilities ₹1,00,000. Calculate debt-equity, proprietary, total assets to debt and debt to capital employed ratios. (4 marks)

Try it first, then show the solutionSolution

SF = 6,00,000; long-term debt = 3,00,000; total assets = 6,00,000 + 3,00,000 + 1,00,000 = 10,00,000.
Debt-equity = 0.5 : 1; proprietary = 6,00,000 ÷ 10,00,000 = 0.6 : 1.
Total assets to debt = 10,00,000 ÷ 3,00,000 = 3.33 : 1.
Debt to capital employed = 3,00,000 ÷ 9,00,000 = 0.33 : 1.

Answer: D/E 0.5 : 1; proprietary 0.6 : 1; TA to debt 3.33 : 1; debt to CE 0.33 : 1.

Example 3: Interest coverage from profit after tax · 3 marks · Short answerHarder board level

Profit after interest and tax is ₹1,80,000; tax rate 40%; the company has 10% debentures of ₹5,00,000. Calculate the interest coverage ratio. (3 marks)

Try it first, then show the solutionSolution

PBT = 1,80,000 ÷ 0.6 = ₹3,00,000.
Interest = 10% × 5,00,000 = ₹50,000; PBIT = 3,50,000.
Interest coverage = 3,50,000 ÷ 50,000 = 7 times.

Answer: 7 times.

Example 4: Effect of transactions on debt-equity · 4 marks · Short answerHarder board level

Long-term debt is ₹3,00,000 and shareholders' funds ₹6,00,000. Show, with figures, the effect on the debt-equity ratio of each separately: (i) issue of equity shares for cash ₹1,00,000; (ii) issue of debentures ₹1,00,000; (iii) redemption of debentures ₹50,000 in cash; (iv) issue of bonus shares ₹1,00,000 from reserves. (4 marks)

Try it first, then show the solutionSolution

(i) 3,00,000 ÷ 7,00,000 = 0.43 : 1: decrease.
(ii) 4,00,000 ÷ 6,00,000 = 0.67 : 1: increase.
(iii) 2,50,000 ÷ 6,00,000 = 0.42 : 1: decrease.
(iv) Equity unchanged: 0.5 : 1, no change.

Answer: (i) Decrease; (ii) increase; (iii) decrease; (iv) no change.

Example 5: Working back from debt-equity · 4 marks · Short answerHOTS / competency

A company's debt-equity ratio is 2 : 1; total assets are ₹15,00,000 and current liabilities ₹3,00,000. Find long-term debt, shareholders' funds and the proprietary ratio. (4 marks)

Try it first, then show the solutionSolution

Capital employed = 15,00,000 − 3,00,000 = ₹12,00,000 = debt + equity.
Debt = 2/3 × 12,00,000 = ₹8,00,000; equity = ₹4,00,000.
Proprietary ratio = 4,00,000 ÷ 15,00,000 = 0.27 : 1.

Answer: Long-term debt ₹8,00,000; shareholders' funds ₹4,00,000; proprietary ratio 0.27 : 1.

Example 6: Reading a high debt-equity ratio · 1 mark · Assertion-reasonHOTS / competency

Assertion (A): A high debt-equity ratio indicates greater risk for long-term lenders.
Reason (R): A high ratio means the firm relies more on borrowed funds and has a smaller owners' cushion.
(a) Both A and R are true, and R is the correct explanation of A.
(b) Both A and R are true, but R is not the correct explanation of A.
(c) A is true, but R is false.
(d) A is false, but R is true.

Try it first, then show the solutionSolution

Less owners' money means less margin of safety for lenders. R explains A.

Answer: (a) Both A and R are true, and R is the correct explanation of A.

Where students lose marks in Solvency Ratios

The slips examiners see most often, and what to write instead.

Mistake: Including current liabilities in debt
Treating all liabilities as debt.
Wrong working
Debt = 3,00,000 + 1,00,000 = 4,00,000.
Right working
Debt = long-term borrowings + long-term provisions = 3,00,000.
Do this: Solvency ratios use long-term debt only.
Usually costs: 1 mark.
Mistake: Using PAT for interest coverage
Taking the last profit line.
Wrong working
1,80,000 ÷ 50,000 = 3.6 times.
Right working
PBIT 3,50,000 ÷ 50,000 = 7 times.
Do this: Add back tax and interest.
Usually costs: 1-2 marks.
Mistake: Ignoring a debit balance of profit and loss
Adding all equity items as positive.
Wrong working
SF = 4,00,000 + 1,00,000 + 50,000.
Right working
SF = 4,00,000 + 1,00,000 − 50,000 = 4,50,000.
Do this: A debit balance reduces reserves and surplus.
Usually costs: 1 mark.
Mistake: Saying bonus shares lower the debt-equity ratio
Thinking share capital rises.
Wrong working
Equity up, ratio down.
Right working
Reserves fall by the same amount: no change.
Do this: Look at total shareholders' funds, not just capital.
Usually costs: 1 mark.

Exam tips

Show the three building blocks (debt, equity, total assets) as separate working lines.
Express ratios as x : 1 and interest coverage in times.
In effect questions, state 'increase/decrease/no change' with the new ratio.
Solvency ratios appear in 1-mark MCQs and 4-mark ratio questions.

Practice questions on Solvency Ratios

Write each answer on paper first. Open the hint only if you are stuck, and the answer only when you have finished.

Q1 · 1 mark · MCQBoard level
Proprietary ratio is:
(a) Shareholders' funds ÷ Total assets
(b) Long-term debt ÷ Shareholders' funds
(c) Total assets ÷ Long-term debt
(d) Shareholders' funds ÷ Current assets
Hint
Owners' share of assets.
Answer
(a) Shareholders' funds ÷ Total assets
Q2 · 1 mark · MCQBoard level
A company's debt-equity ratio is 3 : 1. Which of the following will decrease it?
(a) Issue of debentures
(b) Issue of equity shares for cash
(c) Issue of bonus shares
(d) Purchase of goods on credit
Hint
Raise equity, debt unchanged.
Answer
(b) Issue of equity shares for cash
Q3 · 3 marks · Short answerBoard level
Total assets ₹9,00,000; long-term debt ₹3,00,000; current liabilities ₹1,50,000. Calculate the total assets to debt ratio and debt-equity ratio. (3 marks)
Hint
SF = TA − debt − CL.
Answer
Total assets to debt = 9,00,000 ÷ 3,00,000 = 3 : 1. SF = 4,50,000; debt-equity = 3,00,000 ÷ 4,50,000 = 0.67 : 1.
Q4 · 1 mark · Very short answerHarder board level
Profit before tax ₹4,00,000; interest on long-term loans ₹1,00,000. Calculate the interest coverage ratio. (1 mark)
Hint
Add back interest.
Answer
PBIT = 5,00,000; ratio = 5 times.
Q5 · 3 marks · Short answerHarder board level
Share capital ₹4,00,000; general reserve ₹1,00,000; debit balance of the Statement of Profit and Loss ₹50,000; 9% debentures ₹3,00,000; long-term provisions ₹50,000. Calculate the debt-equity ratio. (3 marks)
Hint
SF 4,50,000; debt 3,50,000.
Answer
SF = 4,50,000; debt = 3,50,000; debt-equity = 0.78 : 1.
Q6 · 3 marks · Short answerHarder board level
A company's proprietary ratio is 0.8 : 1 (shareholders' funds ₹4,00,000; total assets ₹5,00,000). What happens to it if machinery of ₹50,000 is bought on short-term credit? (3 marks)
Hint
Total assets rise; equity unchanged.
Answer
Total assets = 5,50,000; proprietary ratio = 4,00,000 ÷ 5,50,000 = 0.73 : 1, a decrease.
Q7 · 3 marks · Short answerHarder board level
Shareholders' funds ₹6,00,000; long-term debt ₹2,00,000. Calculate the debt to capital employed ratio and explain it. (3 marks)
Hint
CE = 8,00,000.
Answer
2,00,000 ÷ 8,00,000 = 0.25 : 1: a quarter of long-term funds is borrowed; three quarters is owners' money.
Q8 · 1 mark · Assertion-reasonHarder board level
Assertion (A): Interest coverage ratio is calculated on profit after tax.
Reason (R): Interest coverage ratio is net profit before interest and tax divided by interest on long-term debt.
(a) Both A and R are true, and R is the correct explanation of A.
(b) Both A and R are true, but R is not the correct explanation of A.
(c) A is true, but R is false.
(d) A is false, but R is true.
Hint
Which profit?
Answer
(d) A is false, but R is true.
Q9 · 3 marks · Short answerHOTS / competency
A company's proprietary ratio is 0.5 : 1, total assets are ₹10,00,000 and current liabilities ₹2,00,000. Calculate shareholders' funds, long-term debt and the debt-equity ratio. (3 marks)
Hint
SF = 0.5 × TA.
Answer
SF = ₹5,00,000; long-term debt = 10,00,000 − 5,00,000 − 2,00,000 = ₹3,00,000; debt-equity = 0.6 : 1.
Q10 · 3 marks · Short answerHOTS / competency
Firm P has a debt-equity ratio of 2.5 : 1 (debt ₹10,00,000; equity ₹4,00,000) and Firm Q of 0.4 : 1 (debt ₹2,00,000; equity ₹5,00,000). Which is safer for a new lender, and when might P's owners still prefer their structure? (3 marks)
Hint
Risk vs return to owners.
Answer
Q is safer: lenders have a larger owners' cushion and lower interest burden. P's owners may prefer high debt if the business earns more on capital than the interest rate, since the extra profit goes to a small equity base (higher return on equity), though at higher risk.

Test your recall

Answer in your head or on paper first, then open the card. Pulling an answer out of memory makes it stick far better than re-reading.

1.Long-term debt in solvency ratios includes?Show answer
Long-term borrowings and long-term provisions.
2.Effect of issuing bonus shares on debt-equity?Show answer
No change.
3.PAT ₹1,20,000, tax ₹30,000, interest ₹50,000: PBIT?Show answer
₹2,00,000.
4.Formula for total assets to debt ratio?Show answer
Total assets ÷ long-term debt.
5.Capital employed equals?Show answer
Shareholders' funds + long-term debt (= total assets − current liabilities).

Solvency Ratios: frequently asked questions

What are solvency ratios in Class 12?

Ratios measuring long-term financial strength: debt-equity, debt to capital employed, total assets to debt, proprietary and interest coverage ratios.

What is a safe debt-equity ratio?

About 2 : 1 is commonly treated as the safe upper limit; lower means more owners' money and lower risk.

Are current liabilities part of debt in the debt-equity ratio?

No; only long-term borrowings and long-term provisions.

What does an interest coverage ratio of 7 mean?

Profit before interest and tax is seven times the interest on long-term debt, so interest is well covered.