Ratio Analysis Rising Stars Academy provided the following information on its 20

Question

Ratio Analysis

Rising Stars Academy provided the following information on its 2013 balance sheet and statement of cash flows:

Required:

1. Calculate the following ratios for Rising Stars. Round your answers to three decimal places.

a. Debt to equity

b. Debt to total assets

c. Long-term debt to equity

d. Times interest earned (accrual basis)

e. Times interest earned (cash basis)

2. Conceptual Connection: Interpret these results.

The input in the box below will not be graded, but may be reviewed and considered by your instructor.

Explanation / Answer

Calculate the following ratios & Interpret these results

a) Debt to equity = Total Liabilities / Shareholders' Equity = 8972 / 29803 = 0.301

Debt to Equity ratio is the proportion of total liabilities to its Total equity. Debt to Equity ratio measures the proportion in which the assets are financed by the debts and the equity . A lower value of debt to equity ratio is favorable whereas Higher debt to equity ratio is unfavorable as it shows that business depends more on loans taken from external sources by paying interest

b) Debt to total assets = Total Liabilities / Total Assets = 8972 / 38775 = 0.231

Debt to total assets ratio indicates a percentage of total assets that are financed by by Debts , In this case the debt to total assets ratio tells you that around 23% of the of the assets are financed by external loans and thus bears a lesser risk as a higher percentage of Debt to total assets indicates more risk.

c) Long-term debt to equity = Long Term Liabilities / Shareholders' Equity = 4400 / 29803 = 0.148

Long term Debt-to-Equity ratio is the ratio of Long term liabilities of a business to its shareholders' equity. It is a leverage ratio and it measures the degree to which the assets of the business are financed by the long term debts and the shareholders' equity of a business . Lower values of long term debt-to-equity ratio are favorable indicating less risk. Higher debt-to-equity ratio is unfavorable because it means that the business relies more on long term external financing thus it is at higher risk and ends up paying huge Interest at for long term debts

d) Times interest earned (accrual basis) = Earnings before Interest and Tax (EBIT) / Interest Expense = 1223 / 398 = 3.073

Times interest earned is the ratio of earnings before interest and tax (EBIT) to the interest expense - It is a solvency ratio indicating the ability to pay off its debts. Higher value of times interest earned ratio is favorable indicating   greater ability to repay its interest and debt and a Lower value is unfavorable. In this case it is favourable

e) Times interest earned cash basis) = adjusted Operating cash flow / Interest Expense = 1165/ 398 = 2.927

Times interest earned- cabasis is the ratio of Cash flowing to the interest expense - Similar to accrual basis however here we judge the cash position of the business for its interest repayment capacity as sometimes Firm may report good Profit but still face issue with cash flow and a solid Cash Balance or Cash flow is needed to payoff the debts regularly - Higher value of times interest earned ratio is favorable indicating   greater ability to repay its interest and debt and a Lower value is unfavorable. In this case it is favourable

A Long Term Debt 4400 F Interest Expense 398 B Total Liabilities 8972 G Net Income 559 C Total Assets 38775 H Interest Payments 432 D Total Equity 29803 I Cash Flows from Operations 1015 E Operating Income 1223 J Income Tax expenses 266 K Income Taxes Paid 150 EBIT ( G+F+J) 1223 adjusted Operating cash flow ( I + k ) 1165

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