A LevelAccountingCambridge (CIE)Revision NotesFinancial AccountingAnalysis & Communication of Accounting InformationSolvency Ratios

Solvency Ratios (Cambridge (CIE) A Level Accounting): Revision Note

Exam code: 9706

Written by: Dan Finlay

Reviewed by: Lucy Kirkham

Updated on 8 April 2026

What are solvency ratios?

Solvency ratios assess a business's long-term financial health by measuring its ability to meet long-term obligations
- They look at debt repayments and interest payments

You need to know the following solvency ratios:
- Interest cover
- Gearing ratio

Interest cover

What is interest cover?

What is the formula?	$\frac{Profit from operations}{Interest payable}$
How should the value be written?	Write as the number of times (X times)
How should the value be rounded?	Round to two decimal places
What does the value mean?	The value shows how many times the business's operating profit covers its interest obligations
How can the ratio be improved?	Look for sources of finance with lower interest payments Increase profit by increasing income or reducing expenses

The following is a rough guide to interpret the value
- Above 3 times means the business can comfortably cover the interest
- Between 2 and 3 times means it is acceptable but it might be tight
- Between 1 and 2 times means the business is at risk of being unable to manage its debts
- Below 1 times means the business is making a loss after interest

Worked Example

T plc provides the following information for the year ended 31 December 2025.

	$
Profit before tax	115 000
8% debentures (repayable 2030)	250 000
10% bank loan (repayable 2035)	150 000

Calculate, to two decimal places, the interest cover ratio of T plc at 31 December 2025.

Answer:

Calculate the debenture interest

8% × $250 000 = $20 000

Calculate the bank loan interest

10% × $150 000 = $15 000

Add together

$20 000 + $15 000 = $35 000

Add the interest to the profit before tax to find the profit from operations

$115 000 + $35 000 = $150 000

Calculate the interest cover
- $\frac{Profit from operations}{Interest payable}$

$\frac{150 000}{35 000} = 4.285714 . . .$

Round to two decimal places

4.29 times

Gearing ratio

What is the gearing ratio?

What is the formula?	$\frac{Fixed cost capital}{Total capital} \times 100$ which is $\frac{Non - current liabilities}{Issued ordinary share capital + all reserves + non - current liabilities} \times 100$
How should the value be written?	Write as a percentage (X%)
How should the value be rounded?	Round to two decimal places
What does the value mean?	The value shows the proportion of the total long-term capital that is provided by debt (non-current liabilities) rather than by shareholders
How can the ratio be improved?	Issue shares rather than take out loans Repay non-current liabilities using retained profits or cash Retain more profits to increase equity

If the ratio is below 50%, then the company is low geared and is primarily equity financed
- It is a lower financial risk to lenders
If the ratio is above 50%, then the company is high geared and is primarily debt financed
- It is a higher financial risk to lenders
- The company might struggle to borrow additional funds
If the gearing ratio increases then:
- the company is increasing its reliance on debt
- the amount of interest that the company needs to pay is increasing

Examiner Tips and Tricks

The official formula might look confusing, so it might be easier to think of it as

$\frac{Non - current liabilities}{Capital employed} \times 100$

You know from the ROCE ratio that the capital employed is just the equity plus the non-current liabilities.

Worked Example

T plc provides the following information for the year ended 31 December 2025.

	$
8% debentures (repayable 2030)	250 000
10% bank loan (repayable 2035)	150 000
Ordinary share capital	500 000
Share premium	60 000
Revaluation reserve	30 000
Retained earnings	20 000
Bank overdraft	5 000

Calculate, to two decimal places, the gearing ratio of T plc at 31 December 2025.

Answer:

Calculate the total non-current liabilities

$250 000 + $150 000 = $400 000

Calculate the capital employed

$500 000 + $60 000 + $30 000 + $20 000 + $400 000 = $1 010 000

Calculate the gearing ratio
- $\frac{Fixed cost capital}{Total capital} \times 100$

$\frac{400 000}{1 010 000} \times 100 = 39.603960 . . .$

Round to two decimal places

39.60%

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Solvency Ratios (Cambridge (CIE) A Level Accounting): Revision Note

What are solvency ratios?

Interest cover

What is interest cover?

Worked Example

Gearing ratio

What is the gearing ratio?

Examiner Tips and Tricks

Worked Example

Unlock more, it's free!

Join the 100,000+ Students that ❤️ Save My Exams

Author: Dan Finlay

Reviewer: Lucy Kirkham