Question

In: Accounting

According to the leverage measures that are conducted from looking at company's income statement and balance...

According to the leverage measures that are conducted from looking at company's income statement and balance sheet, and comparing with the market averages; how can we decide whether to give long-term credit to the company?

long term debt ratio --> company = market average

long-term debt to equity ratio --> company = Market aver.

Total Debt Ratio --> Company worse than Market av.

Times Interest Earned --> Company worse than Market av.

Cash Coverage Ratio --> Company worse than Market average

Briefly Discuss.

Solutions

Expert Solution

Long term debt ratio can be calculated as = Long term debt / total assets.

As given in question that the company has ratio equal to the market average. It means that the company has adequate ratio which is to be needed to meet the benchmark. The ideal ratio should not exceed 15%.

Long term debt to equity ratio can be calculated as = Long term debt / shareholders equity.

As given in question that the company has ratio equal to the market average. It means that the company has adequate ratio which is to be needed to meet the benchmark. The ideal ratio is 2:1. A company should employ more of debt in its capital structure. As the company met the standard it means that the company is having sufficient debt capital as required in relation to equity.

Total debt ratio is calculated as = Total liabilities / total assets

As given in question that the company has ratio very lower to the market average. It means that it does not meet the standards. The higher the ratio the more risky it it. The comapny might have high amount of total liabilities as compared to total assets. The equity portion is lower and the current liabilities might have a bigger share.

Times interest earned is calculated as = EBIT / interest expense

As given in question that the company has ratio very lower to the market average. It means that the company is not having sufficient profits to pay out interest expenses. The higher the ratio is better and as shown the ratio is worse than the average required. The company should earn enough profits to pay out liabilities.

Cash coverage ratio is calculated as = cash and cash equivalents / current liabilities

As given in question that the company has ratio very lower to the market average. It means that the company relies on inventory and credit sales more than the cash in its current assets structure. A company should have enough of cash to payout the immediate current liabilities. Cash being being the most liquid can pay out obligations more easily than other assets. High investment in credit sales might increase the chances of bad debt.

As far as ratios are evaluated, the company should not give a long term credit title. It might have ratio meeting the requirements but having below average performance in most areas and is not having enough of liquid asset and profits for survival. Thus, the company has lesser chances to survive in long run.

ekkarill92 answered 2 years ago
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