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### COVERAGE RATIOS

These ratios are computed to know the solvency of the firm in making the periodical payment of interest and preference dividends. The interest and preference dividends are to be paid irrespective of the earnings available in the hands of the firm. In other words, these are known as fixed commitment charge of the firm.
Interest Coverage Ratio
The firms are expected to make the payment of interest on the amount of borrowings without fail This ratio facilitates the prospective lender to study the strength of the enterprise in making the payment of interest regularly out of the total income. To study the capacity in making the payment of interest is known as interest coverage ratio or debt service coverage ratio. The ability or capacity is analysed only on the basis of Earnings before interest and taxes (EBIT) available in the hands of the firms. Greater the ratio means that better the capacity of the firm in making the payment of interest as well as greater the safety and vice versa Lesser the times the ratio means that meager the cushion of the firm which may lead to affect the solvency position of the firm in making payment of interest regularly.
Dividend Coverage Ratio
It illustrates the firms’ ability in making the payment of preference dividend out of the earnings available in the hands of the firm after the payment of taxation. If the size of the Profits after taxation is greater means that greater the cushion for the payment of preference dividend and vice versa. The preference dividends are to be paid without fail irrespective of the profits available in the hands of the firm after the taxation.
Profitability Ratios
The ratios are measuring the profitability of the firms in various angles viz
On sales
On investments
On capital employed and so on
While discussing the measure of profitability of the firm, the profits are normally classified
into various categories
Gross Profit
Net Profit
Earnings before interest and taxes
Earnings after taxation and so on
All profitability ratios are normally expressed only in terms of (%). The return is normally
expressed only in terms of percentage which warrant the expression of this ratio to be
also in percentage.
GP Ratio: The ratio elucidates the relationship in between the Gross profit and sales
volume. It facilitates to study the profit earning capacity of the firm out of the manufacturing or
NP Ratio: The ratio expresses the relationship in between the Net profit and sales
volume. It facilitates to portray the overall operating efficiency of the firm. The net
profit ratio is an indicator of over all earning capacity of the firm in terms of return out
of sales volume.
Operating profit ratio: The operating ratio is establishing the relationship in between
the cost of goods sold and operating expenses with the total sales volume
Return on Assets: This ratio portrays the relationship in between the earnings and total
assets employed in the business enterprise. It highlights the effective utilization of the
assets of the firm through the determination of return on total assets employed