Question

Compute and Interpret Liquidity, Solvency and Coverage Ratios Information from the balance sheet, income statement, and statement of cash flows for Nike follows. Refer to these fina NIKE, INC. Consolidated Statements of Income Year Ended December 31 (In millions) 2019 2018 Revenues $39.117 $36,397 Cost of sales 21,643 20,441 Gross profit 17,474 15,956 Demand creation expense 3.753 3,577 Operating overhead expense 8.949 7,934 Total selling and administrative expense 12,702 11,511 Interest expense (Income), net 49 54 Other (income) expense, net (78) 66 Income before income taxes 4.801 4,325 Income tax expense 772 2,392 Net income $ 4,029 S 1.933

Answer 1

Liquidity Ratios

Current Ratio: It is a liquidity ratio that measures a company's ability to pay short-term obligations or those due within one year. It tells investors and analysts how a company can maximize the current assets on its balance sheet to satidfy its current debt and other payables. The ideal current ratio is 1 to 2 which means that the business has 2 times more current assets than current liabilities to cover its debts. A current ratio below 1 means that the company doesn't have enough liquid assets to cover its short-term liabilities.

Formula : Current Ratio = Current Assets / Current Liabilities

= 16525 / 7866 = 2.10 times

It means company's current assets is 2.10 times more than current liabilities and it has enough liquid assets to cover is short-term liabilities.

Acid-Test Ratio : The term "Acid-test ratio" is also known as quick ratio. The most basic definition od acid-test ratio is that, "it measures current(short-term) liquidity and position of the company", To do the analysis accountants weights current assets against the current liabilities which result in the ratio that highlights the liquidity of the company. Inventory is not included in the calculation of the acid-test ratio as it can be quite difficult for a business to convert all its inventory into cash within a short period of time.

Formula : Acid-test Ratio = Current Assets - Inventory / Current Liabilities

= 16525-5622 / 7866

= 1.39 times

Absolute Liquidity Ratio: This ratio measures the total liquidity available to the company. This ratio only considers marketable securities ans cash available to the company. This ratio only tests short-term liquidity in terms of cash, marketable securities and current investment.

Formula: Cash + Marketable Securities / Current Liabilities

= 4466 + 197 / 7866

= 0.59 times

Solvency Ratios

Solvency ratios, also called leverage ratios, measures a company's ability to sustain operations indefinitely by comparing debt levels with equity, assets and earnings. In other words, solvency ratios identify going concern isuues and firm's ability to pay its bill in the long run.

Solvency ratios show a company's ability to make payments and pay off its long-term obligations to creditors,bondholders, and banks. Better solvency ratio indicate a more creditworthy and financially sound company in the long-term

Common Solvency ratios are as follows

Debt-Equity Ratio: The debt-equity ratio is a financial, liquidity ratio that compares a company's total debt to the total equity. The debt-equity ratio shows percentage of company financing that comes from creditors and investors, Higher the debt to equity ratio indicates that more creditor financing (bank loan) is used than investor financing.

Formula : Debt / Equity x 100

= 3464 / 9040 x 100 = 38.31 %

Equity Ratio : It measures the amount of assets that are financed by owner's investment by comparing the total equity in the company to the total assets

Formula : Total Equity / Total Assets

= 9040 / 23717 = 0.3811

Debt Ratio: It measures a firm's total liabilities as a percentage of its total assets. In sense, the ratio shows a company's ability to pay off its liabilities with its assets. In other words, this shows how many assets the company must sell in order to pay off all of its liabilities. This ratio measures the financial leverage of a company

Formula : Total Debt / Total Assets

= 6811 / 23717 = 0.2872

Coverage Ratios: A coverage ratio, measures company's ability to service its debt and meet its financial obligations.The higher the coverage ratio, the easier it should be to make interest payments on its debt or pay dividends.Common coverage ratios include the interest coverage ratio, debt service coverage ratio, and asset coerage ratio

Interest Coverage ratio : It measures the ability of a company to pay the interest expense on its debt. This ratio is also known as times interest earned ratio

Formula : EBIT / Interest Expense

= EBIT = Gross profit + other income - selling and administrative expense

= 17474 + 79 - 12702 = 4851

Interest Expense = 49

Interest Coverage Ratio = 4851 / 49 = 99 Times

An interest coverage ratio of two or higher is generally considered satisfactory

Debt Service Coverage Ratio : It measures how well a company is able to pay its entire debt service. Debt service includes all principal and interest payments due to be made in the near term

Formula : Net Operating Income / Total Debt Service

Net Operating Income = Net Income (pre tax) + Interest Expense + Depreciation + Amortization

= 4801 + 49 + 34 + 15 = 4899

Total Debt Service = Principal + Interest

= 6 + 49 = 55

Debt Service Coverage Ratio = 4899 / 55 = 89 times

Asset Coverage Ratio: It measure how well a company can repay its debts by selling or liquidating its assets.The higher the asset coverage ratio, the more times a company can cover its debt.

Formula: (Asset - Intangible Assets ) - (Current Liabilities - Short-term debt) / Total Debt

Intangible assets = Goodwill + other identifiable intangible assets = 154 + 283 = 437

= ( 23717 - 437 ) - (7866 - 0) / 3464

= 15414 / 3464

= 4.44 times