The document discusses capital structure measures that can be used to analyze a firm's financial health and solvency. It identifies three key measures: 1) Capital structure, which includes a firm's sources of financing through equity and debt. 2) Earning power, which is the firm's ability to generate cash flows. 3) Asset coverage, which provides assurance to creditors that the firm can pay its long-term obligations by analyzing ratios of assets to debt and equity. Various asset coverage ratios are explained, including fixed asset to equity ratio and net tangible asset ratios.

1. Interpretation of Capital
Structure Measures
Financial Management 2
K. V. Mendoza, MBA

2. Solvency
• Solvency is a
firm’s financial
ability to survive in
the long term by
paying its long-
term obligations

3. Capital Structures Measures
1. Capital Structure
2. Earning Power
3. Asset Coverage

4. Capital Structure Measures
1. Capital Structure-
includes the firm’s
sources of financing,
through:
 Equity
 Debt

5. Capital Structure Measures
2. Earning Power
(earnings
coverage)- is the
capacity of the
firm’s operations
to produce cash
inflows.

6. Capital Structure Measures
3. Asset Coverage-
provides assurance to
creditors that the firm
will be solvent in the
long term. Assets are
the source of earning
power.
Asset Composition-is
ordinarily indicative of the
financing structure.

7. Capital Structure Measures
3. Asset Coverage
Ratio of fixed
asset to equity
capital-indicates
the extent to which
shareholders
have financed non
current assets.
Fixed assets
Total Equity
 the greater the ratio,
the greater the risk
 If the ratio exceeds 1.0
the firm has some debt
financing

8. Capital Structure Measures
3. Asset Coverage
Ratio of net
tangible assets
to long term
debt-is a measure
of the firm’s ability
to pay its non
current obligations
Net Tangible Assets
Long Term Debt
 A high ratio assures
creditor’s of the firm’s
solvency

9. Capital Structure Measures
3. Asset Coverage
Ratio of total
liabilities to net
tangible assets-is
a measure of the
security provided
to all creditors by
the firm’s more
readily realizable
assets.
Total Liabilities
Net Tangible Assets

10. Capital Structure Measures
3. Asset Coverage
Fixed charge
coverage ratio
(earnings to fixed
charge ratio)- extends
the times interest
earned ratio to include
the interest portion
associated with long
term lease obligations.
EBIT+ Interest Portion of
Operating Leases
Interest + Interest Portion of
Operating Leases

11. END OF LECTURE