Question

Selected balance sheet and income statement information from Verizon Communications Inc. follows.
$ millions 2016 2015
Current assets . . . . . . . . . . . . . . . . . . . . . . . . . $ 26,395 $ 22,355 Current liabilities. . . . . . . . . . . . . . . . . . . . . . . . 30,340 35,052 Total debt . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 108,078 109,729 Total liabilities . . . . . . . . . . . . . . . . . . . . . . . . . . 220,148 226,333 Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 24,032 17,842 Earnings before interest and taxes. . . . . . . . . . 27,059 33,060 Interest expense. . . . . . . . . . . . . . . . . . . . . . . . 4,376 4,920 Net cash flow from operating activities . . . . . . 22,715 38,930
b. Compute times interest earned, total liabilities-to-equity, and cash from operations to total debt ratios for each year and discuss any trends for each. Do you have any concerns about the extent of Verizon’s financial leverage and the company’s ability to meet interest obligations? Explain.

c. Verizon’s capital expenditures are expected to increase substantially as it seeks to respond to competitive pressures to upgrade the quality of its communications infrastructure. Assess Verizon’s liquidity and solvency in light of this strategic direction?

Answer 1

(b):

		2016	2015
a	Earnings before interest and taxes	27,059	33,060
b	Interest expense	4,376	4,920
c = a/b	Times interest earned	6.18	6.72

		2016	2015
a	Total liabilities	220,148	226,333
b	Equity	24,032	17,842
c = a/b	Total liabilities to equity	9.16	12.69

		2016	2015
a	Cash from operations	22,715	38,930
b	Total debt	108,078	109,729
c = a/b	Cash from operations to total debt	0.21	0.35

From the above figures we can see that in terms of trends the company’s time’s interest earned ratio declined in 2016. At the same time its total liabilities to equity ratio also declined in 2016. Cash from operations to total debt also declined in 2016.

The company’s time’s interest earned ratio declined in 2016 to 6.18 from 6.72 from the previous year. Though the decline is not very huge it still indicates declining ability of the company to service its debt. Financial leverage is not a concern as its liabilities to equity ratio declined in 2016 but the company will do well to still pare this figure down further from the current level of 9.16 for 2016. The decline in cash flow operations to total debt ratio in 2016 is a cause of concern because this is a coverage ratio and the decline shows that the company will take longer to repay its debt if it devoted all of its cash flow to debt repayment.

(c): Substantial increase in capex (i.e. capital expenditure) can likely put pressure on Verizon’s liquidity and solvency in the near future. Usually high amounts of capex are financed with debt and so this leads to decline in working capital. The same can happen with Verizon as well. So its solvency ratios like debt to equity ratio (total debt/total equity) and its time’s interest earned ratio can deteriorate in the light of increased levels of capex. Its liquidity as measured by its current ratio (current assets/current liabilities) and quick ratio [(current assets – inventories)/current liabilities] can also take a hit and deteriorate in future.

The company's current ratio is shown for the 2 years for your reference:

		2016	2015
a	Current assets	26,395.00	22,355.00
b	Current liabilities	30,340.00	35,052.00
c = a/b	Current Ratio	0.87	0.64