Question

Countrywide financial statements presented signs of risk related to the possibility of losses with its loans. Explain one of those signs

Answer 1

Answer

In the given question, Countrywide Financial Statements presented signs of risks w.r.t. possibility of losses with its loans.

There are a number of different ways that a business can face financial risk. Some may be internal and others may be driven by external factors such as fluctuations in the financial markets or exchange rates.

Given below are some warning signals of a troubled company

1.         Dwindling Cash or losses

2.         Interest/Loan Installment Payments in doubt

3.         Switching Auditors

4.         Dividend Cut

5.         Top management resignations

           

  Explanation of Interest/Loan Installment Payments in doubt (Pt. # 2)

A company's income statement will show what it pays to service its debt. There are metrics and ratios that measure a company's ability to cover its debt obligations. The current ratio (or cash ratio) is a calculation that assists in determining a company's ability to pay short-term debt obligations. It is calculated by dividing current assets by current liabilities. A ratio higher than 1.5 indicates that a company will have a high chance of being able to pay off its debt, whereas, a ratio of less than 1.5 indicates that a company will not be able to pay off its debt. In the above case, it can be one of the possible sign of risk regarding losses with its loans

In addition to the avove, the debt-service coverage ratio (DSCR) is a measurement of the cash flow available to pay current debt obligations. The ratio states net operating income as a multiple of debt obligations due within one year, including interest, principal, sinking-fund and lease payments. A ratio of less than 1 is not optimal because it reflects the company's inability to service its current debt obligations with operating income alone.