Question

Calculate (i) Debt-Equity Ratio; (ii) Total Assets to Debt Ratio; and (iii) Proprietary Ratio from the following particulars :

$\begin{array}{cc}\text{Particulars}& \text{Rs.}\\ \text{Equity Share Capital}& 3,00,000\\ \text{Preference Share Capital}& 1,00,000\\ \text{General Reserve}& 60,000\\ \text{Profit \& Loss Balance}& 40,000\\ \text{12 \% Mortgage Loan}& 1,80,000\\ \text{Current Liabilities}& 1,20,000\\ \text{Non Current Assets}& 4,50,000\\ \text{Current Assets}& 3,50,000\end{array}$

What conclusions do you draw from the above ratios ?

Answer 1

(i) Debt Equity Ratio
$=\frac{Debt}{Equity}or\frac{\text{Long-term Debts}}{\text{Shareholder's Funds}}$

Long term Debts = 12% Mortgage Loan

= Rs. 1,80,000

Shareholder's Funds
= Equity Share Capital + Preference Share Capital + General Reserve + P & L Balance

= Rs. 3,00,000 + Rs. 1,00,000 + Rs. 60,000 + Rs. 40,000

= Rs. 5,00,000

Hence, Debt Equity Ratio $=\frac{1,80,000}{5,00,000}=0.36:1$

Comments : This ratio indicates what proportion of funds are provided by long-term debts in comparison to shareholder's funds. Generally, the ratio should not be more than 2 : 1 Debt-Equity ratio of the above company is 0.36 : 1 which indicates that long-term debts are only 0.36 in comparison to shareholder's funds. Hence, it may be considered that the long- term financial position of the company is very sound.

(ii) Total Assets to Debt Ratio $=\frac{TotalAssets}{Debt}$

Total Assets = Non Current Assets + Current Assets

= Rs. 4,50,000 + Rs. 3,50,000 = Rs. 8,00,000

Total Assets to Debt Ratio $=\frac{8,00,000}{1,80,000}=4.44:1$

Comments : Total assets of this company are 4.44 times in comparison to long-term debts of the company. The higher ratio indicates the use oif lower debts in financing the assets which means higher security to lenders.

(iii) Proprietary Ratio = $\frac{\text{Shareholder's Funds}}{\text{Total Assets}}$

$=\frac{Rs.5,00,000}{Rs.8,00,000}=0.625or62.5\%$

Comments : Shareholder's Funds of this company are 62.5 % in comparison to total assets of the company. In other words, 62.5% of the total assets of the company are funded by equity which indicates that the long-term financial position of the company is very sound.