Question

In: Finance

what does the following ratios over a period of three years indicate? 1) total debt ratio...

what does the following ratios over a period of three years indicate?

1) total debt ratio indicate

2016 - 1.02
2017- 0.97
2018 - 0.96

2) long term debt ratio

2016 - 0.47
2017 - 0.53
2018 - 0.51

3) operation cash flow ratio

2016 - 0.82
2017 - 0.76
2018 - 0.68

4) interest coverage ratio

2016 - 3.77
2017 - 3.49
2018 - 5.06

5) quick ratio

2016 - 0.93
2017 - 1.20
2018 - 1.17

Solutions

Expert Solution

1) Total debt ratio

Meaning: Debt Ratio is defined as the Total Debt in proportion to Total Assets. It is a measure of the company’s leverage and is expressed in the percentage format. The ratio is calculated by dividing Total Debt by Total Assets. A ratio of greater than 1 indicates that the company is using a lot of its assets to fund its debt.

Indication: The given figures indicate that the company has had a very high Debt Ratio over all the years. In 2018, the company's Debt was 96% of its Total Assets. A super majority of the Total Assets are being used to fund Debt which is a bad sign. Even though the ratio shows a deceasing trend in the Debt as a proportion of Total Assets, the company is at an risky position relating to its survival.

2) Long term debt ratio

Meaning: Debt Ratio is defined as the Total Long-Term Debt in proportion to Total Assets. This ratio is a measure of the long-term performance of the company and is expressed in the percentage format. The ratio is calculated by dividing Total Long-Term Debt by Total Assets. A ratio of less than 0.50 is generally considered to be a good sign.

Indication: The given data indicates that the ratio has been increasing over the years which is generally a bad sign. This can have two implications. Firstly, the company will have to pay higher debt payments in the form of interest and principle which will lower its potential to take advantage of opportunities. Secondly, the company will have increased tax advantage due to higher Interest payments. The net effect on the company's financials will be determine by the higher of these. If the advantage exceeds the cost, it will have a positive impact and vice-versa.

3) Operation cash flow ratio

Meaning: Operating Cash Flow Ratio is defined as the Operating Cash Flow in proportion to the Current Liabilities. The ratio is an indication of liquidity and indicates by how much is the company’s Operating Cash Flow covering its Current Liabilities. The ratio is calculated by dividing Operating Cash Flow by Current Liabilities. A ratio of greater than 1 indicates extra cash generated over necessary to cover Current Liabilities.

Indication: The Operating Cash Flow of the company is less than 1 for all the years indicating that it is not enough alone to cover the Current Liabilities. This is bad indication because the company . However, the increasing shows that in future the company may attain a ratio of greater than 1. Although, another indication can be that the company had taken up a project that had bad cash flows initially but has now started to make gains.

4) Interest coverage ratio

Meaning: The Interest Coverage Ratio is calculated by dividing the company’s Earnings Before Interest and Taxes (EBIT) by the company’s Interest Payments for a particular period. The ratio determines how many times will be a company be able to cover its Interest Payments using its EBIT.

Indication: The interest coverage ratio of the company is high enough and has also been showing an increasing trend. It has taken a sudden hike in 2018 which is a very good sign. This means that the company is able to pay 5.06 times of its Interest Payments by its EBIT.

5) Quick ratio

Meaning: The Quick Ratio is a measure of short-term liquidity. It indicates how well a company will be able to meet its short-term obligations with its quick assets. The ratio is calculated by dividing Current Assets less Inventory and Prepaid Expenses by Current Liabilities. The higher the ratio, the stronger the company’s short-term performance.

Indication: The quick ratio had increased substantially in 2017 but then took a slight fall in 2018. Overall, the Quick Ratio seems to indicate a good sign as it has been greater than 1 in the recent two years. Since the ratio is greater than 1, the company has extra quick assets which may be used elsewhere rather than just meeting the current liabilities.


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