Question

What information does current, quick, and debt ratios provide? If you were concerned about the result of the ratios, what could be done to adjust these ratios? In what ways could these ratios be negatively impacted? When assessing the results of these ratios, what advice would you have for this organization if it was considering securing financing for a major capital expense?

Answer 1

What information does current, quick, and debt ratios provide?

The ‘debt to equity’ ratio is one of the most fundamental measures in corporate finance. It is a great test of the financial strength of a company. Although used universally, it, unfortunately, turns up under many different names and with different methods of calculation. This causes some confusion which we will try to remove in this chapter. The purpose of the ratio is to measure the mix of funds in the balance sheet and to make a comparison between those funds that have been supplied by the owners (equity) and those which have been borrowed (debt).

Note that the first two definitions concentrate on formal interest-bearing debt, i.e., that sourced from banks or other financial institutions. In bank calculations, these are the definitions most commonly used. The final definition includes trade creditors plus all accruals, such as dividends, tax, and other miscellaneous amounts

However, from the companies’ viewpoint, debt due to a supplier is just as real and as important as that due to a bank. There are therefore good arguments for including all debt in the calculation of the debt to equity ratio.

If you were concerned about the result of the ratios, what could be done to adjust these ratios?

companies take on debt and incur this extra risk? The answer lies in the relative costs. Debt costs less than equity funds. By adding debt to its balance sheet, a company can generally improve its profitability, add to its share price, increase the wealth of its shareholders and develop greater potential for growth. In this answer, if corporate wants to adjust this ratio as per management control then management should go for structured equity over debt. Henceforth the Debt should not go above the roof of Equity. In other sense, Equity is one source of income of the company so it’s always should be in control above debt.

In what ways could these ratios be negatively impacted?

Negative cash flow is meant that sufficient funds are not being generated internally to fund the assets required by the operations. Companies in such a heavily negative cash flow position have a form of financial diabetes. They have a perpetual cash hemorrhage because the values of certain operating parameters are out of balance. It is necessary to identify and quantify the factors behind this condition.

When assessing the results of these ratios, what advice would you have for this organization if it was considering securing financing for a major capital expense?

Current Ratio

A business's current ratio is equal to its current assets divided by its current liabilities. More expenditures tend to increase a company's total liabilities, which decreases the current ratio. The current ratio is an indicator of how well a company can satisfy its current liabilities with its current assets.

Efficiency Ratio

A company's efficiency ratio is equal to its total expenses over a given period divided by its revenue over the same period. Efficiency ratio is commonly used to calculate the strength of banks and other financial institutions. A low-efficiency ratio is preferable since a higher ratio indicates expenses are high compared to revenues.

capital Expenditure Ratio

A capital expenditure is an expense a company incurs when it invests in assets that might increase profit in the future. For example, if a small-scale farmer buys a new tractor to make it easier to harvest crops, the money he spends on the new vehicle is a capital expenditure. A company's capital expenditure ratio is the amount of money it spends on capital divided by total sales. It indicates how much a company is investing to facilitate growth.

Debt-to-income Ratio

The debt-to-income ratio is the total amount of money an individual or business pays to satisfy debts each month, divided by total income or revenue. Lenders use your debt-to-income ratio to help determine whether to approve you for loans. Student debt, credit card debt,