Question

Kansai Paints Co. Statement of Retained Earnings For the year ending December 31, 2012 2012 Retained earnings, January 1 723,000 Add: Net income for year 245,000 Total 968,000 Deduct Dividends: On preferred stock 40,000 On common stock 45,000 Total 85,000 Retained earnings, December 31 883,000 2011 581,800 211,200 793,000 40,000 30,000 70.000 723,000 2011 Kansai Paints Co. Balance Sheet As on December 31, 2012 2012 Current Assets: Cash 175,000 Short-term investment 150,000 Accounts receivables 425,000 Inventories 720,000 Prepaid expenses 30,000 Total Current Assets 1,500,000 Long-term investment 250,000 Property, plant & equipment (net) 2,093,000 Total Assets 3,843,000 125.000 50,000 325,000 480,000 20,000 1,000,000 225,000 1,948,000 3,173,000 750,000 650,000 Current liabilities Long-term liabilities Mortgage payable Bonds payable Total long-term liabilities Total liabilities 410,000 800,000 1,210,000 1,960,000 800,000 800,000 1,450,000 Stockholder equity Preferred stock ($ 100 Par) 500,000 500,000 Common stock ($ 10 Par) 500,000 500,000 Retained earnings 883,000 723,000 Total Stockholder equity 1,883,000 1,723,000 Total liabilities and stock holder equity 3,843,000 3,173,000 Required: a) Highlight the ratios which Ahmed should use to analyze company's situation. b) Using ratio analysis highlight the problem areas (if any) of Kansai Paints Co. c) Compare the ratios of two years to help decide that the loan should be extended or not.

Answer 1

Question # 1:

a. As a lender, the most relevant ratios are the liquidity ratios and the solvency ratios.

While the liquidity ratios indicate the ability of the firm to honour its short term payment obligations, the solvency ratios would tell you whether the borrower would be able to pay back liabilities in the long term.

Liquidity Ratios		2012	2011
Current Ratio	Total Current Assets / Total Current Liabilities	2.0 x	1.53 x
Quick Ratio	( Cash + Short Term Investments ) / Current Liabilities	1.0 x	0.77 x
Cash Ratio	Cash / Current Liabilities	0.23 x	0.19 x
Solvency Ratios
Debt Ratio	Total Liabilities / Total Assets	51 %	45.7%
Debt to Equity Ratio	Total Liabilities / Total Stockholders Equity	1.04 x	0.84 x
Times Interest Earned	Income from Operations / Interest Expense	5.95x	6.75 x

b. While the liquidity ratios are just comfortable, but there is not much elbow room there. But the solvency ratios are not too encouraging. The debt ratio and debt equity ratio are causes for concern, and the times interest earned. While the debt and debt equity ratios have increased between 2011 and 2012, times interest earned has decreased. Therefore, the company already has high financial leverage on its books. With financial leverage comes the risk of being unable to pay interest liability, and also the liability to repay principal amounts, if there should be a sudden downturn in the economy.

c. Granting the fresh loan would strain the liquidity of the borrower even more, and further increase its financial risk. Therefore, Kansai should be asked to inject some fresh equity, before the loan can be granted.