Question

Measuring Ability to Pay Liabilities

LeBronson's Companies Balance Sheet May 31, 2018 and 2017 LeBronson's companies has 10,000 common shares outstanding during 2018

Assets			Liabilities
	2018	2017		2018	2017
Cash	2,400	900.00	Total Current Liabilties	28,000	13,200
Short-Term Investments	28,000	9,000	Long-Term Liabilities	13,900	10,300
Accounts Receivable	7,500	5,200	Total Liabilities	41,900	23,500
Merchandise Inventory	6,900	8,600	Stockholder's Equity
Other Current Assets	8,000	1,500	Common Stock	11,000	11,000
Total Current Assets	52,800	25,200	Retained Earnings	29,900	19,700
All Other Assets	30,000	29,000	Total Equity	40,900	30,700
Total Assets	82,800	54,200	Total Liabilities and Equity	82,800	54,200

Calculating these objectives

A. Calculate the debt ratio and the debt to equity ratio at May 31, 2018, for LeBronson's Companies.

B. Is LeBronson's ability to pay its liabilities good or bad? Explain your decision or findings.

Answer 1

Debt Ratio = Total Liabilities / Total Assets = 41900 / 82800 = 0.506

Debt to Equity Ratio = Total Liabilities / Total Equity = 41900 / 40900 = 1.02

Debt Ratio

A lower debt ratio usually implies a more stable business with the potential of longevity because a company with lower ratio also has lower overall debt. A debt ratio of .5 is often considered to be less risky. This means that the company has twice as many assets as liabilities. Or said a different way, this company’s liabilities are only 50 percent of its total assets. Essentially, only its creditors own half of the company’s assets and the shareholders own the remainder of the assets.

Debt Equity Ratio

A debt to equity ratio of 1 would mean that investors and creditors have an equal stake in the business assets. Companies with a higher debt to equity ratio are considered more risky to creditors and investors than companies with a lower ratio. Unlike equity financing, debt must be repaid to the lender. Since debt financing also requires debt servicing or regular interest payments, debt can be a far more expensive form of financing than equity financing. Companies leveraging large amounts of debt might not be able to make the payments. Creditors view a higher debt to equity ratio as risky because it shows that the investors haven’t funded the operations as much as creditors have.