Question

QUESTION 3 (15 marks) HEALTH and SAFETY (PTY) LTD (H&S) is a wholesaler of Personal Protective Equipment. At the Beginning of the year 2020, H&S expanded its retail business by adding over 50 shops in order to meet the demand for protective gear. The following information has been extracted from the comparative financial statements included in the company's 2019 annual report (all amounts are in thousands of Rands): Total liabilities Total shareholders' equity Dec. 31, 2019 R26 000 34 000 Dec. 31, 2018 R18 000 38 000 Depreciation expense Interest expense Income tax expense Net income / (profit) Net cash provided by (used for) operations Total dividends paid Cash used to purchase plant assets Payments on long-term debt R 2000 3 400 12 600 6 000 41 000 2 000 32 000 1 600 R6 000 3 200 18 100 15 000 (400) 12 000 18 000 1 800 1) Using the information provided above, calculate the following for 2019 and 2018: a. Debt-to-equity ratio (at each year-end) b. Times interests earned ratio 2) Comment briefly on the company's solvency. 3) What other ratios will help you assess the solvency? What information will they provide that you do not already have concecoing the company's solvency? (2)

Answer 1

Part 1
	2019	Calculation	2018	Calculation
Debt to Equity ratio(Total Liabilities / Total shareholder's equity)	0.76	26,000 / 34,000	0.47	18,000 / 38,000
Times Interest Earned Ratio = Income before Interest and Taxes or EBIT/Interest Expenses	6.47	22,000 / 3,400	11.34	36,300 / 3,200
Part 2
As far as Liquidity of the companies are concerned, the following explanation can be carried out:
The Debt to equity ratio in 2019 has increased from 2018 by 0.29 points which shows that the company is diluting its ownership in the company by increasing debts.
Due to this reason the Times Interest earned ratio has also decreased which goes to shows that the company's earnings before interest and taxes is not enough to cater its debt holders rate of interest.
Regardless of the fact that the company has diluted its ownership by increasing debts and reducing common shareholdings, the Solvency of the company is still intact and is not in grave danger.
Part 3
The other solvency ratio example is Debt to Assets ratio
For the calculation of Debt to Assets ratio, the information given in the above question are enough as Total Assets =Total Debt + Total Shareholder's Equity
So there is no other information required assess the company's solvency