Question

QUESTION 3                                                                                                      

HEALTH and SAFETY (PTY) LTD (H&S) is a wholesaler of Personal Protective Equipment. At the Beginning of the year 2020, H&S expanded its retail business by adding over 50 shops in order to meet the demand for protective gear. The following information has been extracted from the comparative financial statements included in the company's 2019 annual report (all amounts are in thousands of Rands):

	Dec. 31, 2019	Dec. 31, 2018
Total liabilities	R26 000	R18 000
Total shareholders' equity	34 000	38 000
Depreciation expense	R 2 000	R 6 000
Interest expense	3 400	3 200
Income tax expense	12 600	18 100
Net income / (profit)	6 000	15 000
Net cash provided by (used for) operations	41 000
Total dividends paid	2 000	12 000
Cash used to purchase plant assets	32 000	18 000
Payments on long-term debt	1 600	1 800
Using the information provided above, calculate the following for 2019 and 2018:             a. Debt-to-equity ratio (at each year-end)                                                (2)
b. Times interests earned ratio                                                                  (2)
Comment briefly on the company's solvency.                                        (4) ​
What other ratios will help you assess the solvency?             What information will they provide that you do not already have             concerning the company's solvency?                                                      (2)

Answer 1

Answer to Part a.

Debt to Equity ratio = Total Liabilities / Total Shareholders’ Equity

Year ended December 31, 2019:
Debt to Equity ratio = 26,000 / 34,000
Debt to Equity ratio = 0.76 times

Year ended December 31, 2018:
Debt to Equity ratio = 18,000 / 38,000
Debt to Equity ratio = 0.47 times

Answer to Part b.

Times Interest earned ratio = EBIT / Interest Expense
Earnings before Interest and Taxes (EBIT) = Net Income + Income Tax Expense + Interest Expense

Year ended December 31, 2019:
Earnings before Interest and Taxes (EBIT) = 6,000 + 12,600 + 3,400
Earnings before Interest and Taxes (EBIT) = 22,000

Times Interest earned ratio = 22,000 / 3,400
Times Interest earned ratio = 6.47 times

Year ended December 31, 2018:
Earnings before Interest and Taxes (EBIT) = 15,000 + 18,100 + 3,200
Earnings before Interest and Taxes (EBIT) = 36,300

Times Interest earned ratio = 36,300 / 3,200
Times Interest earned ratio = 11.34 times

Answer to Part c.

The Debt to equity ratio has increased in the year ended December 31, 2019 as compared to December 31, 2018 which indicates the company’s liquidity position has improved over the year and it a good sign. An increase in Debt to equity ratio indicates business uses higher debt to finance its growth and in such companies, shareholders will likely to invest.

The other ratios which can help to access the solvency are:

· Long Term Debt to equity ratio

· Debt ratio

· Financial leverage

· Interest coverage

They will provide information about the company’s ability to debts and its regular obligation i.e. interest payment etc.