Financial Statement Analysis. A- Write A summary of the Leverage ratio, compare,

Question

Financial Statement Analysis.

A- Write A summary of the Leverage ratio, compare, contrast and analyze.

Leverage Ratios: Debt ratio 41.14 % 40.22 0% Long-term debt to total capitalization 21.54 % 21.20 0% Debt to equity 0.70 times 0.67 times Financial leverage (FL) 1.70 times 1.67 times Times interest earned 4.55 times 4.33 times 40.64 times Cash interest coverage 6.66 times 19.85 times 153.86 times Fixed charge coverage 3.57 times 3.38 times 23.71 times Cash flow adequacy 1.37 times 4.26 times 6.12 times

Explanation / Answer

Financial leverage refers to the use of debt finance .while debt capital is a cheaper source of finance it is also a riskier source of finance. Leverage ratio help in assessing the risk arising from the use of debt capital. Two types of ratio are used to analyse financial leverage1 structural ratios and 2 coverage ratio.

Structure ratio is based on the proportion of debt equity in the financial structure of the firm.

Coverage ratio shows the relationship between debt servicing commitment and the source for meeting these burdens.

Analysis of ratio in this question following are –

1 Debt ratio- the firm may be interested in knowing the proportion of interest bearing debt (also called funded debt) in capital structure. It may be therefore computed by debt ratio by divide total debt by capital employed or net asst .

Debt ratio=total debt (TD)/total debt (TD) +net worth (NW)

               =Total debt (TD)/capital employed (CE)

In this question debt ratio is

1st year debt ratio is 41.14 means that the lender have financed 41.14%of companies net asset (CE),sly in 2nd year lender has financed 40.22% of companies net asset (CE), it is obviously implies that owner finance increased in 2nd year by .92%

2 LONG TERM DEBT TO TOTAL CAPITALISATION RATIO-

This ratio is calculated by dividing the firm’s total long-term debt by its total available capital.

The total available capital is the sum of the firm’s long-term debt, and its common and preferred stock

= LONG term debt / (Long-term debt + Preferred stock + Common STOCK)

The greater a company's leverage, the higher the ratio. Generally, companies with higher ratios are thought to be more risky because they have more liabilities and less equity.

In this question long term debt to total capitalisation ratio is 21.54%in 1st year and 21.20%2nd year which means the company is less risky, and companies risk is reduced in 2nd year compare to 1st year.

3. DEBT TO EQUITY RATIO- This relationship describes the lender contribution for each dollar of the owners contribution .debt equity ratio is directly computed by dividing total debt by net worth

D/E ratio=TOTAL DEBT/NET WORTH

Lower values of debt-to-equity ratio are favourable indicating less risk. Higher debt-to-equity ratio is unfavourable because it means that the business relies more on external lenders thus it is at higher risk, especially at higher interest rates. A debt-to-equity ratio of 1.00 means that half of the assets of a business are financed by debts and half by shareholders' equity. A value higher than 1.00 means that more assets are financed by debt that those financed by money of shareholders' and vice versa.

             In this question D/E ratio is .70 and .67 which is less than 1 it indicates less risky as less asset is financed from outside.

4 Financial leverage-the use of fixed charges source of fund such as debt and preference capital along with the owner’s equity in the capital structure is described as financial leverage or gearing or trading on equity. The more debt financing a company uses, the higher its financial leverage. A high degree of financial leverage means high interest payments, which negatively affect the company's bottom-line earnings per share. If the financial leverage ratio of a company is higher than 2-to-1, it indicates financial weakness.

          Here financial leverage is 1.70 in first year and in 2nd year it is 1.67 shows positive effect on EPS.

5 Time interest earned-It shows how many times the annual interest expenses are covered by the net operating income (income before interest and tax) of the company.

=income before interest and tax/interest expenses

Generally, a ratio of 2 or higher is considered adequate to protect the creditors’ interest in the firm. A ratio of less than 1 means the company is likely to have problems in paying interest on its borrowings.

Here in both the years time interest earned is much higher than 1 which means company is having adequate to protect the creditors’ interest in the firm

6 Cash interest coverage= It is a term that indicates the enterprise’s ability to pay interest from generated cash flow It is used to test firms debt serving capacity.

= EBIT/INTERST

The lower the interest coverage ratio, the higher the company's debt burden and the greater the possibility of bankruptcy or default and vise versa.

Here its 6.6 in 1st year and 19.85 in 2nd years which means in 2nd year company is very much good condition to pay debt burden

6 Cash adequacy ratio- cash flows from operations are compared to the payments made for long-term debt reductions, fixed asset acquisitions, and dividends to shareholders.

=Cash flow from operations ÷ (Long-term debt paid + Fixed assets purchased + Cash dividends distributed)

A ratio of 1 or more indicates that the company's operations produce sufficient cash to meet necessary business obligations. here its adequate in both the years.

company is in good condition in both years and improving more in 2nd year

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