Key Management Ratios, 4th Edition

10

Financial strength

Interest cover

• ‘Debt to equity’ ratio (D/E)
• Leverage
• Summary

Over-trading is among tradesmen as over-lifting is among strong men; such people, vain of their strength…at last lift at something too heavy for them, over-strain their sinews, break some ofnature’s bands and are cripples ever after.

DANIEL DEFOE (1660–1731)

By ‘financial strength’ we mean a company’s ability to withstand operating setbacks. In the previous chapter we looked at the short-term position. The long-term situation is even more important. To arrive at an assessment for this we look at a company’s total borrowings, and we relate them to its trading cash flow. The first measure we use is referred to as ‘interest cover’.

Interest cover

This ratio ...