Question

What is the debt ratio in the below problem?

4.0 Liquidity, acid test and debt ratios

The person in charge of the finances of the company MGT, S.A. wants to know the company's situation concerning the industrial sector to which it belongs. For this, it has the following information regarding the industry:

1. General liquidity ratio is 1.55; the acid test is 1.20, and the ratio between the available and the current liabilities is 0.95.
2. The debt ratio stands at 1.25. The margin on sales is 21%. The investment rotation is 1.45 times.
3. Economic profitability is around 23%, and financial profitability is 29%

The data referred to the company (in thousands of €) are the following:

Assets		Liability and Net Equity
Non-current asset (net)	170	Equity	125
Stocks of finished products	45	Reservations	25
Clients	65	External Resources	105
Banks	70	Loans	65
		Supplier	30
Total Assets	350	Total Net Equity	350

In addition, it is known that:

• Sales are € 250,000 and its direct cost of € 105,000.
• Amortization of € 70,000.
• Long-term debt generates interest at 5%, short-term bank loans at 7%, and the departure of suppliers does not accrue any interest.
• The Corporation Tax is 25%.

Calculate the liquidity, acid test and debt ratios, and compare them with the sector data. It also calculates the economic and financial returns, and the margin on sales and investment rotation, even making a comparison between the company and sector. #2 page 13 debt ratio pages 14, liquidity also in #2

4.1 Liquidity Current assets/current liabilities

	Sector	Company
General liquidity ratio	1.55	1.89
Acid test ratio	1.20	1.42
Cash to liquidity ratio	0.93	0.74
Debt ratio	1.25	1.75
Margin on Sales	21.00%	58.00%
Investment rotation	1.45	0.85
Economic Profitability	23.00%	16.68%
Financial Profitability	29.00%	19.56%

The general liquidity ratio (current assets / current liabilities) of the company works out 1.89 times when compared to 1.55 times recorded by overall Industry (sector). The general liquidity ratio suggested that the company can pay off the current obligations on demand by liquidating its current assets better than the same approach by the Industry.

4.2 Acid Test Current assets-inventories/current liabilities

The Acid test ratio ((Current assets-Inventory)/current liabilities) suggests that company can pay off the current obligations much more faster than the sane approach by the Industry

The cash to liability ratio recorded by the Industry is better than the company because the company holds less cash balance when compared to the Industry recordings

4.3 Debt Ratio Debt ratio= Total Debt/Total Equity_missing Total liabilities/total assets

Answer 1

Debt Ratio = Total debt/ total assets

The debt ratio is a financial ratio that measures the extent of a company’s leverage. The debt ratio is defined as the ratio of total debt to total assets. It can be interpreted as the proportion of a company’s assets that are financed by debt. A ratio greater than 1 shows that a considerable portion of debt is funded by assets.

If we take the given figures,

                                                            Debt ratio = 1.25

                                             Total debt/total assets = 1.25

                                                  Total debt/350,000 = 1.25

                                                            Total debt = $ 437,500

Now, the problem that arises is that the balance sheet has to match, and a company has a debt ratio above 1 can’t prove that in the balance sheet. Such a company is believed to have a weak financial condition and there are defaults in interest payments along with installments.

Thus, it can be assumed here that the term – Total debt/liabilities is inclusive of the outstanding interest payments to be made to the banks.

Since much information is not available in the question regarding interest payments,

We can always mention reasonable assumptions used to solve the question.