Question

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   

(400)  

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   

1)        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)

2)        Comment briefly on the company's solvency.                                        (4)

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3)        What other ratios will help you assess the solvency?

Answer 1

Solution:

1)

a) Debt to equity ratio = Total debt/Total equity

Year 2019 = 26000/34000

= 0.76

Year 2018 = 18000/38000

= 0.47

b) we have to calculate EBIT first,

EBIT for 2019 = Net income + interest expense + Tax expense

= 6000 + 12600 +3400

= 22000

EBIT for 2018 = 15000 + 18100 + 3200

= 36300

Times interest earned ratio

For 2019 = EBIT / Interest expense

= 22000 / 3400

= 6.47

For 2018 = 36300 / 3200

= 11.34

2) As company is having healthy debt to equity ratio in both the years and its EBIT is also sufficient to cover the interest expense, comapny can be said to have a bright future ahead solvently.

3) We can also calculate solvency ratio to assess solvency of company which is given by

= (Net profit + Depreciation) / Total Liabilities

For 2019 = 6000 + 2000 / 26000

= 0.30 i.e 30%

For 2018 = 15000 + 6000 / 18000

= 1.16 i.e 116%

So in general a solvency ratio of more than 20% is cnsidered good. so we can say that company is solvent on this basis also.