Stability Ratios – Definition & Meaning

Stability ratios are financial metrics used to evaluate a company’s ability to meet its long-term obligations and maintain financial balance over time. They focus on the relationship between debt, equity, and assets, helping investors measure financial risk and sustainability.

Key Takeaways

• Stability ratios in one sentence: Measures of how securely a company’s capital structure can support its obligations.
• Why they matter: They highlight long-term solvency and the balance between debt and equity.
• Context or usage: Widely used by investors, lenders, and credit rating agencies to assess risk.
• Synonyms: Also referred to as solvency ratios.

What Are Stability Ratios?

Stability ratios examine the degree of financial leverage and the capacity of a business to remain solvent. Unlike liquidity ratios, which measure short-term survival, stability ratios focus on long-term commitments and resilience.

Commonly analyzed stability ratios include:

• Debt-to-Equity Ratio
• Equity Ratio
• Debt Ratio
• Interest Coverage Ratio

These ratios show how much of a company’s financing comes from debt versus equity and whether earnings can cover financial costs.

How Stability Ratios Work

Here are the most used formulas:

Debt-to-Equity Ratio = Total Liabilities ÷ Shareholders’ Equity
Shows leverage. A higher ratio means heavier reliance on debt.

Equity Ratio = Shareholders’ Equity ÷ Total Assets
Indicates the proportion of assets financed by equity.

Debt Ratio = Total Liabilities ÷ Total Assets
Reveals how much of assets are financed by debt.

Interest Coverage Ratio = EBIT ÷ Interest Expense
Assesses ability to pay interest; higher is safer.

Example of Stability Ratios in Practice

Suppose a company reports:

• Total Assets = $1,000,000
• Total Liabilities = $600,000
• Shareholders’ Equity = $400,000
• EBIT = $150,000
• Interest Expense = $30,000
• Debt-to-Equity = 600,000 / 400,000 = 1.5
• Equity Ratio = 400,000 / 1,000,000 = 0.40 (40%)
• Debt Ratio = 600,000 / 1,000,000 = 0.60 (60%)
• Interest Coverage = 150,000 / 30,000 = 5.0

Interpretation: The firm is moderately leveraged but comfortably covers interest payments.

Benefits and Considerations

• Pros: Provide clear insight into solvency and risk of over-leverage; help compare companies’ financial resilience.
• Considerations:
  • Ratios vary by industry norms.
  • Should be analyzed over time, not just once.
  • High debt isn’t always bad if supported by stable cash flows.

Related Terms

• Cost of Capital – the required return for providers of debt and equity.
• Free Cash Flow (FCF) – cash generated after necessary reinvestment.
• Operating Leverage – sensitivity of profit to changes in revenue.
• Economic Moat – sustainable competitive advantage supporting high returns.