Finante engleza
Test 1 PDF Imprimare Email

Please consider the following topics for the first test:

- autonomy and leverage;

- financial stability;

- asset structure;

- liquidity and solvency.

 
Liquidity and solvency PDF Imprimare Email

Liquidity and solvency

The table below contains the financial balance sheet of a company over a 2 – year period:

Financial balance sheet

1

2

Nr.

Assets

Year 1

Year 2

1

Intangible assets

10,000

10,000

2

Tangible assets

50,000

190,000

3

Financial assets

20,000

20,000

4

Fixed assets

80,000

220,000

5

Inventories

50,000

25,000

6

Accounts receivable

80,000

35,000

… 7

Costumer receivables

70,000

30,000

… 8

Other receivables

10,000

5,000

9

Cash and cash equivalents

130,000

20,000

10

a) Short term investments

50,000

5,000

11

b) Cash

80,000

15,000

12

Current assets

260,000

80,000

13

Total assets

340,000

300,000

 

 

 

 

Nr.

Equity and Liabilities

Year 1

Year 2

1

Equity

250,000

160,000

2

Long - term debt

10,000

30,000

… 3

Financial long - term debt

10,000

30,000

… 4

Non - financial long - term debt

 

 

5

Long - term capital

260,000

190,000

6

Current liabilities

80,000

110,000

… 7

Financial short - term debt

5,000

15,000

… 9

Non - financial short - term debt

75,000

95,000

… - 10

Accounts payable

55,000

75,000

… - 11

Other operating debt

20,000

20,000

12

Total debt

90,000

140,000

13

Total equity and liabilities

340,000

300,000

 

 

Extract from the profit and loss account

Nr.

Incomes and expenses

Year 1

Year 2

1

Sales

600,000

650,000

2

Fixed operating expenses

 

 

3

Variable operating expenses

 

 

4

Depreciation

5,000

20,000

5

Net operating profit / loss

30,000

32,000

6

Interest

1,500

4,500

7

Net profit / loss

25,000

23,000

 

Extract of the cash flow statement

Nr.

Other information

Year 1

Year 2

1

Long - term loans principal payements

5,000

15,000

2

Long - term loans interest payements

1,500

4,500

3

Dividends

10,000

15,000

4

Duration of the period

360

360

 

 

Tasks: Evaluate the liquidity and solvency of the company for the first 2 years.

Steps to follow:

1. Calculate the financial ratios that reflect information about the liquidity and solvency for both years.

2. Evaluate the liquidity and solvency of the company for year 1 by comparing the calculated values of the ratios to the optimum values.

3. Evaluate the liquidity and solvency of the company for year 2 by comparing the calculated values of the ratios to the optimum values.

4. Analyze the dinamics of the ratios.

5. Specify the causes of the dinamics.

6. Offer improvement solutions for year 3.

 

 


 

1.      Calculation of the liquidity and solvency ratios for year 1 and year 2

Nr.crt.

Liquidity

Year 1

Year 2

1

Current assets

260,000

80,000

2

Current assets absolute deviation

-

-180,000

3

Current assets growth index

-

30.8%

4

Current assets growth rate

-

-69.2%

5

Current liabilities

80,000

110,000

6

Current liabilities absolute deviation

-

30,000

7

Current liabilities growth index

-

137.5%

8

Current liabilities growth rate

-

37.5%

9

Current ratio

3.25

0.73

10

Current ratio growth index

-

22.4%

 

image001

 

Nr.crt.

Liquidity

Year 1

Year 2

1

Current assets - Inventories

210,000

55,000

2

Current liabilities

80,000

110,000

3

Quick ratio

2.63

0.50

4

Quick ratio growth index

-

19.0%

 

image003

 

Nr.crt.

Liquidity

Year 1

Year 2

1

Current assets - Inventories - Accounts receivable

130,000

20,000

2

Current liabilities

80,000

110,000

3

Spot ratio

1.63

0.18

4

Spot ratio growth index

-

11.2%

 

image005

 

 

 

 

 

Nr.crt.

Solvency

Year 1

Year 2

1

Total assets

340,000

300,000

2

Total assets absolute deviation

-

-40,000

3

Total assets growth index

-

88.2%

4

Total assets growth rate

-

-11.8%

5

Total debt

90,000

140,000

6

Total debt absolute deviation

-

50,000

7

Total debt growth index

-

155.6%

8

Total debt growth rate

-

55.6%

9

Solvency ratio

378%

214%

10

Solvency ratio growth index

-

56.7%

 

image007

 

Nr.crt.

Solvency

Year 1

Year 2

1

Net operating profit / loss

30,000

32,000

2

Net operating profit / loss absolute deviation

-

2,000

3

Net operating profit / loss growth index

-

106.7%

4

Net operating profit / loss growth rate

-

6.7%

5

Interest

1,500

4,500

6

Interest absolute deviation

-

3,000

7

Interest growth index

-

300.0%

8

Interest growth rate

-

200.0%

9

Times interest earned ratio

2000%

711%

10

Times interest earned ratio growth index

-

35.6%

 

 

 

image009

 

Nr.crt.

Solvency

Year 1

Year 2

1

Net profit / loss

25,000

23,000

2

Depreciation

5,000

20,000

3

Earnings before depreciation

30,000

43,000

4

Dividends

10,000

15,000

5

Self - financement

20,000

28,000

6

Self - financement absolute deviation

-

8,000

7

Self - financement growth index

-

140.0%

8

Self - financement growth rate

-

40.0%

9

Long - term loans principal payements

5,000

15,000

10

Long - term loans interest payements

1,500

4,500

11

Debt service

6,500

19,500

12

Debt service absolute deviation

-

13,000

13

Debt service growth index

-

300.0%

14

Debt service growth rate

-

200.0%

15

Debt service coverage ratio

330.8%

166.7%

16

Debt service coverage ratio growth index

-

50.4%

 

image011

 

2.      Evaluation of the liquidity and solvency of the company for year 1

The current ratio for year 1 is of 3.25. Statistically speaking, the level of the current ratio should be between 1 and 2. The value of 3.25 does not show that the company will be able to pay its short-term debt for sure, but it suggests that there are small chances of the company not being able to pay. On the other hand, a large value of the ratio shows signs of poor financial management. With the value of the ratio being significantly over 2, one can conclude that the risks of the company not being able to pay its short-term debt are low, but the risks are being kept at a low level by accepting a lack of efficiency in the management of the financing sources.

The quick ratio shows a similar picture as the current ratio. The optimum level for the quick ratio is considered to be within the interval [0.6, 1). The high value of the quick ratio shows low risks of the company not being able to pay its short-term debt, as the existing cash and receivables turning into cash in less than one year are enough to cover 2.63 times the liabilities that must be paid in cash in less than 1 year. On the other hand, it also shows that the copany holds too much of its capital as cash and receivables. Basically, from the financing point of vue, more than half of the cash and receivables from the first year are being financed through long – term capital. This suggests that either the levels of cash and receivables are too high, or the level of the short-term debt is too low (the company uses too much long – term capital for financing its assets, with the long – term capital being more expensive than the short-term debt).

The spot ratio shows that all short-term debt is held as cash, together with an important part of the long – term capital. With the level of this ratio being over 1, it can be said for sure that the company is able to pay in cash its short-term debt, but the lack of efficiency in the management of the financing sources is equally obvious. The optimum interval for this ratio is considered to be [0.2, 0.6).

The solvency ratio shows that the market value of all assets covers 378% the value of total debt. The ratio is used for judging the payment capacity of the company in the event of bankruptcy. While the liquidity ratios make sense in the hypothesis of the continuation of the activity, the solvency ratio has in vue the scenario of all operation processes being halted.

The minimum value of the ratio to be accepted is of 133%. The assets are valuated in the financial balance sheet at market value – the estimated price to be offerd by the potential buyers under market conditions. Still, in the event of total liquidation, the prices that are estimated to be obtained for the assets are signifficantly lower than market prices.

This means that by covering out of the market value of total assets only 100% of the total debt, the value of the assets in case of total liquidation will not be enough to cover the debt. In addition, the liquidation process generates expenses that are to be covered also.

The times interest earned ratio for the first year has a value of 2000%, which means that the interest can be paid 20 times over of the operating profits. Being able to support the interest payments (which are financial expenses) of the operating profit is essential, as the loans that generate the interest expenses are normally injected into the operating activity. The company cannot be expected to pay the interest of financial revenues, so a ratio lower than 100% is not to be accepted.

Still, the main objectives of the company are not to pay interest, but to use the loans to finance its assets and to manage the assets to generate profits. Being able to pay the interest of the operating profits is important, but, it this case, being able to pay the interest so easy is a consequence of the company not using enough leverage (the debt ratio is of only 26.5%).

The debt service coverage ratio shows whether the company can make the principal payments and the interest payments for long – term loans of the self – financement. A level of at least 100% is required.

The value of the ratio (330.8%) shows that the company should have no problems paying the debt service of the self financement for year 1. Still, a value greater than 100% does not guarantee the payment capacity (the profits may not be cashed in time to make the payments). On the other hand, the company may pay even if the ratio is lower than 100% (by using cash existent at the beginning of the period, by selling fixed assets or by injecting capital from outside sources).

 

3.      Evaluation of the liquidity and solvency of the company for year 2

All liquidity ratios are for the second year below their lower accepted limits. This does not mean that the company is not able to pay the currents bebts, or that it will go banckrupt. It only shows that the risks of the company not being able to pay the currents debts on time are high, with the efficiency of the financing sources management being high as well. Statistically speaking, the combination of risks / efficiency is disproportioned, with the risks being to high to justify the extra efficiency.

The solvency ratio shows that the company will probably be able to pay its debts by liquidating the assets in case of business failure. The times interest earned ratio suggests that the company can afford to pay the interest from the operating profits, as the debt service coverage ratio shows that the company can cover the debt service for long – term loans of the self financement.

4.      Dinamics of the liquidity and solvency ratios

From one year to the other, all liquidity and solvency ratios decrease, reflecting an increasing level of risk of the company not being able to pay both in case of continuing its activity or in case of business failure.

5.      Causes of the dinamics of the liquidity and solvency ratios

The solvency ratio decreases as the growth index of total assets is lower than the growth index of the liabilities. The growth index of the assets is lower than 100% (the value of the total assets decreases) mainly because of the company’s decision to pay dividends at the beginning of the second year (which reduces both the equity and the cash and cash equivalents). There is also an increase in the value of the tangible assets, as the company makes investments in the second year. As the financing sources decrease through the distribution of dividends, the company is forced to ask for a new long – term bank loan (to make the investment in tangible assets).

As the bank loan is not enough to cover the investment, the company makes efforts to reduce the financing sources invested into current assets (inventories and receivables). The inventories decrease although the sales increase, which is possible only through a better management of the inventories (and thus of the financing sources, which are being kept for a smaller period of time as inventories).

The receivables decrease as well, with the sales increasing, which is only possible by reducing the average collection period.

The liabilities increase through the new bank loan (which affects both financial long – term debt and financial short – term debt), as well as through an increase of the accounts payables.

The growth index of the accounts payables is higher than the growth index of the sales, which shows that the average payment period is increasing.

 

6.      Improvement solutions for year 3

With the level of the liquidity ratios being too low for the second year, the management of the company should try to increase current assets at a higher growth index compared to the current liabilities. This will be posible through the increase of long – term capital (as for year 2, the long – term capital is not enough to finance the fixed assets), through the sale of a part of the fixed assets, or through converting current debt into long-term capital.

The solvency ratios do not necessarily need intervention for the 3rd year.

 
Financial autonomy PDF Imprimare Email

Financial autonomy and financial leverage

The table below contains the financial balance sheet of a company over a 3 – year period:

Financial balance sheet

1

2

3

Nr.

Assets

Year 1

Year 2

Year 3

1

Intangible assets

10,000

10,000

10,000

2

Tangible assets

50,000

150,000

200,000

3

Financial assets

20,000

20,000

20,000

4

Fixed assets

80,000

180,000

230,000

5

Inventories

50,000

50,000

30,000

6

Accounts receivable

80,000

80,000

50,000

… 7

Costumer receivables

70,000

70,000

40,000

… 8

Other receivables

10,000

10,000

10,000

9

Cash and cash equivalents

130,000

30,000

30,000

10

a) Short term investments

50,000

5,000

5,000

11

b) Cash

80,000

25,000

25,000

12

Current assets

260,000

160,000

110,000

13

Total assets

340,000

340,000

340,000

 

 

 

 

 

Nr.

Equity and Liabilities

Year 1

Year 2

Year 3

1

Equity

250,000

150,000

150,000

2

Long - term debt

10,000

90,000

90,000

… 3

Financial long - term debt

10,000

90,000

90,000

… 4

Non - financial long - term debt

 

 

 

5

Long - term capital

260,000

240,000

240,000

6

Current liabilities

80,000

100,000

100,000

… 7

Financial short - term debt

5,000

15,000

15,000

… 9

Non - financial short - term debt

75,000

85,000

85,000

… - 10

Accounts payable

55,000

65,000

65,000

… - 11

Other operating debt

20,000

20,000

20,000

12

Total debt

90,000

190,000

190,000

13

Total equity and liabilities

340,000

340,000

340,000

 

Tasks: Evaluate the financial autonomy and the financial leverage of the company for the first 2 years.

Steps to follow:

1. Calculate the financial ratios that reflect information about the financial autonomy and the financial leverage for both years (year 1 and year 2).

2. Evaluate the financial autonomy and the financial leverage of the company for year 1 by comparing the calculated values of the ratios to the optimum values.

3. Evaluate the financial autonomy and the financial leverage of the company for year 2 by comparing the calculated values of the ratios to the optimum values.

4. Analyze the dinamics of the ratios.

5. Specify the causes of the dinamics.

6. Offer improvement solutions for year 3.

 

1.       Calculation of the financial autonomy ratio and of the debt ratio for year 1 and year 2

 

Nr.crt.

Financial autonomy

Year 1

Year 2

Year 3

1

Equity

250,000

150,000

150,000

2

Equity growth index

-

60.0%

100.0%

3

Equity growth rate

-

-40.0%

0.0%

4

Total equity and liabilities

340,000

340,000

340,000

5

Total equity and liabilities growth index

-

100.0%

100.0%

6

Total equity and liabilities growth rate

-

0.0%

0.0%

7

Autonomy ratio

73.5%

44.1%

44.1%

8

Autonomy ratio growth index

-

60.0%

100.0%

9

Autonomy ratio growth rate

-

-40.0%

0.0%

 

image001

 

 

 

 

 

 

Nr.crt.

Leverage

Year 1

Year 2

Year 3

1

Total debt

90,000

190,000

190,000

2

Total debt growth index

-

211.1%

100.0%

3

Total debt growth rate

-

111.1%

0.0%

4

Total equity and liabilities

340,000

340,000

340,000

5

Total equity and liabilities growth index

-

100.0%

100.0%

6

Total equity and liabilities growth rate

-

0.0%

0.0%

7

Debt ratio

26.5%

55.9%

55.9%

8

Debt ratio growth index

-

211.1%

100.0%

9

Debt ratio growth rate

-

111.1%

0.0%

 

image003

 

2.       Evaluation of the financial autonomy and financial leverage of the company for year 1

For year 1, 73.5 % of the financing sources are represented by equity, the rest of 26.5% being represented by debt (short – term and long-term debt). This means that 73.5% of the assets are being financed through equity.

The higher the autonomy ratio is, the lower the risks related to dependancy of creditors. Thus, the company attains maximum financial atonomy when liabilities are absent. On the other hand, equity is more costly then debt. Companies use debt as a cheaper financing source to boost their return on equity ratios.

Under these circomstances, in order to evaluate the level of the financial autonomy ratio for the first year, a benchmark is needed. Statistically speeking, the optimum percentage of equity in total financing sources is of 66%. A lower level shows less financial autonomy (more dependancy on creditors) as well as more risks related to the debt. Still, a lower level of financial autonomy reflects higher potential in terms of returns.

A higher level of autonomy shows less return potential (based on the lower leverage), but also less dependancy on creditors and less risk related to debt.

 

3.       Evaluation of the financial autonomy and financial leverage of the company for year 2

For year 2, 44.1% of the financing sources are represented by equity, as the rest of 55.9% are represented by debt. Compared to the structure of the financing sources considered to be optimum, statistically speeking, the state of the company for year 2 can be characterised as more risky. On the other hand, the potential in terms of return on equity is higher.

4.       Dinamics of the autonomy ratio and debt ratios

From the first year to the second, the autonomy ratio decreases by a growth index of 60% (a growth rate of -40%). At the same time, the debt ratio increases from 26.5% to 55.9%. These changes in the structure of the financing sources of the company show an increase of the level of risk, but also an increase of the return on equity potential.

5.       Causes of the dinamics of the autonomy ratio and the debt ratios

Mathematically, the autonomy ratio can decrease (have a growth index of less than 100%) if, from one period to the other, the growth index of the equity is lower than the growth index of the total financing sources. In the case of the company being analyzed, the equity has a growth index of 60%, while the value of the total financing sources stays the same (has a growth index of 100%).

Thus, the reasons for the decrease of the autonomy ratio can be found in the reasons for the decrease of the equity. The equity decreases form one year to the other as profits are distributed in year 2 as dividends.

The financing sources of the company do not decrease, as the decrease of the equity is accompanied by an increase of debt. The total debt increases by a growth index of 211.1%, the main causes of this increase being related to the investment in tangible assets made by the company at the begining of year 2, an investment that is being financed mostly by long – term bank loans. The financial short-term debt increases also, as a result of the increase of the principal payments for the long-term loans.

There is also an increase of the accounts payable, from 55,000 in the first year to 65,000 in the second.

 

6. Improvement solutions for year 3.

The optimum level for the financial autonomy ratio is considered to be 66%. With the level of the ratio for year 2 being of only 44.1%, improvement measures for year 3 should target an increasement of the ratio. In order for the autonomy ratio to increas from year 2 to year 3, the growth index of the equity should be higher than the growth index of the total financing sources (equity and liabilities). Several posibilities are to be considered:

-          Increasing the equity through retained earnings or share capital subscriptions.

-          Decreasing the liabilities by redueing the assets or by replacing the liabilities with equity;

-          Increasing both equity and liabilities, but increasing equity by a higher growth index;

-          Decreasing both equity and liabilities by reducing the total value of the assets, but but maintaing a higher growth index of the equity (altough lower than 100%).

Increasing equity through retained earnings is considered to be the most natural solution. However, there may be times that such a solution is not effective: the company needs to make an investment, for which reason it negociates with the bank for a loan; because of poor financial autonomy, the bank asks for an equity increase, before accepting to grant the loan. In such a situation, there may not be enough time to increase the equity through retained earnings.

In other cases, the company may not be able to generate profits at all, which would impose a drastical solution: either increase shared capital or pay part of the debts by reducing the assets.

 

 


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