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

Q1: Health and Safety pvt ltd Solvency ratio calculation.

A. Debt to equity ratio for for year 2019 = Total liabilities / total sharholders' equity

= 26,000 / 34,000 = 0.7647 = 0.765

Debt to equity ratio for year 2018 = Total liabilities / Total shareholders' equity

= 18,000 / 38,000 = 0.4736 = 0.474

B. Time interest earned ratio for year 2019 = EBIT (Earning before interest and expense) / Total interest expense = (Net income+ interest expense+ tax expense) / Total interest expenses

= 6000+ 12,600+3400 /3400 =22,000 / 3400 =6.4705 = 6.471

For the year 2018 = 15,000+18,100+3200 / 3200 =36,300 / 3200 = 11.3437 = 11.344

[Here EBIT = Net income - interest expense- tax expense]

Q2: ANALYSIS;

Debt to equity ratio for year 2019 is 0.765 and for year 2018 it is 0.474 . it shows that in 2019 company have more debt as compare to 2018. but for both year company has less debt or liabilites against equity. it is good .

For year 2019 time int earned ratio is 6.471 show that company has more income to pay its additional interest expense and for year 2018 it is 11.344 which shows that company has greater earning to pay additional interest expenses. So for year 2018 was in better condition for company than year 2019. In both the year company is good condition.

Q3:Other ratios like debt ratio which is total debt to total asset, proprietary ratio which is total Equity to Total asset, and Financial leverage ratio , which is Total Asset to Total equity are available and calculated based on stated formula to evaluate solvency position of firm.