Question

Ms. Beach has asked you to advise him on the long-term debt-paying ability of Aroshell Company.
She provides you with the following ratios:
	2016	2015	2014
Times interest earned	8.2	7.0	4.5
Debt ratio	30%	29%	30%
Debt to tangible net worth	70%	71%	71%
a. Give the implications and the limitations of each item separately and then the collective
influence that could be drawn from them about Aroshell Company's long-term debt position.
b. What warnings should you offer Ms. Beach about the limitations of ratio analysis for the purpose stated here?

Answer 1

a)The implications of the ratios are :

1. The earning ie. EBIT, of the Aroshell company has been good towards the interest coverage. The interest coverage by the earnings has been improving from yr 2014 to yr 2016. So, the long term debt position of the company form the interest payment point is very good and improving.
2. The debt consists of around 30% of the total assets. So, the long term re-payments of the debts is secured.
3. The debt ratio to the tangible net worth is around 70% of the active tangible assets- net worth, in case of liquidation of the company, the debts will be duly paid-out first.

b.

The ratios has the limitations towards 1) working on the past data or results, 2) do not take care of the future variables, 3)ratios shows the relation between the two figures of financial results only, 4) do not count the non-numeric factors for accessing the long term debt position. So, Ms. Beach should be warned about all these limitations of the accessment of position through ratio analysis.