Question

Compute and Interpret Liquidity and Solvency Ratios

Selected balance sheet and income statement information from

Verizon Communications Inc. follows.

$ millions 2015 2014

Current assets . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . $22,280 $29,499

Current liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 35,052 2 7,9 87

Total liabilities. . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 226,798 218,940

Equity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 17,842 13,676

Earnings before interest and taxes . . . . . . . . . . . . . . . . . . . . . . . . . . . . 32,974 21,379

Interest expense, gross . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 4,920 4,915

Net cash flow from operating activities . . . . . . . . . . . . . . . . . . . . . . . . 38,930 30,631

A) Compute the current ratio for each year and discuss any trend in liquidity. What additional infor-

mation about the numbers used to calculate this ratio might be useful in helping us assess liquidity?

Explain.

b. Compute times interest earned and the liabilities-to-equity for each year and discuss any noticeable

change. (The average liabilities-to-equity ratio for the telecommunications industry is 1.7.) Do you

have any concerns about 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 com-

petitive pressures to upgrade the quality of its communication infrastructure. Assess Verizon’s li-

quidity and solvency in light of this strategic direction.

Answer 1

Answer to Part a.

Current Ratio = Current Assets / Current Liabilities

Year 2014:
Current Ratio = 29,499 / 27,987
Current Ratio = 1.05: 1

Year 2015:
Current Ratio = 22,280 / 35,052
Current Ratio = 0.64: 1

Additional information which might be used:
1. Industry Average Current Ratio, so comparison could be made as to performance of Verizon Communication, Inc.

2. Average Time available to make the payment to Current Liabilities.

Answer to Part b.

Times Interest Earned = EBIT / Interest Expense
Total Liabilities to Equity ratio = Total Liabilities /Equity

Year 2014:
Times Interest Earned = 21,379 / 4,915
Times Interest Earned = 4.35 times

Total Liabilities to Equity ratio = 218,940 / 13,676
Total Liabilities to Equity ratio = 16.01 times

Year 2015:
Times Interest Earned = 32,974 / 4,920
Times Interest Earned = 6.70 times

Total Liabilities to Equity ratio = 226,798 / 17,842
Total Liabilities to Equity ratio = 12.71 times

Verizon’s Times Interest earned ratio has increased, and Total Liabilities to Equity ratio has also increased, but slightly as compared to Times Interest earned ratio which indicates, the Company would be able to meet its obligation.

Answer to Part c.

The Verizon’s has grown in terms of profitability and cash flow which could be used to meet the capital expenditure, without additional borrowings through debt or equity.