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Corporate Finance Assignment
Question: Define Short-term solvency Activity Financial leverage Profitability Value Define the following terms
Solution
Short-term solvency
These are liquidity ratios which attempts to measure the business's capabilities to encounter the short term maturing monetary obligations as and when they fall due. That is to say, these ratios seek to determine thecapacity of the business to evademonetarymisery in a short-run (Adelman, 1998). They are three important short term solvency ratios.
Current ratio
This is a ratio which measures the number of times the current obligations can be meet from current assets before they are exhausted. Current assets are resourcesa business supposed to change into cash in a period of one year whereas current liabilities are obligations that must be met in a cash as and when they fall due. The suitability of this rest onthe characteristics of business's industry and the structure of the current resources they have. Current assets should be greater than current liabilities and is usually recommended to be 2: 1.
It is given as current assets divide by current liabilities.
For Example: If a business has current assets i.e. inventory $500, accounts receivables $700, cash at bank $300 and accounts payables $1,000.
To get current ratio, current assets (500 + 700 + 300) divide by current liabilities of 1000
That is 1,500/1,000 = 1.5 times
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Quick ratio
This ratio accepts that inventories should be rather illiquid and if they are sold in anemergency way or manner in order to meet current obligations, the business might end up having difficulty in finding the buyer and eventually end up selling them at a discount or a loss (Kaminsik, 2004). The ratio tries to quantity its liquid assets. To get quick ratio, divide current assets minus inventory by current liabilities.
Using the above example,
To get quick ratio, current assets (700 + 300 - 500) divide by current liabilities of 1000
That is 1,000/1,000 = 1 times
Cash ratio is a modification of acid test ratio measuring the capability of a business's current liabilities most liquid resources. It is calculated as cash in hand + cash at bank divide by current liabilities.
Using the above example, we get cash at bank 300/ 1000 = 0.3 times
Activity Financial leverage
It is also called trading on equity. It refers to the use of debt (by borrowing money) to obtain more resources. It is used to regulate larger amount of resourceswhich will cause the returns on owner's cash investment (Keown, 2005). The increaseof the value will give the owners cash whereas decrease will cause larger loss on owner's cash.
Example: Kevin used his own cash of $500,000 together with $1,000,000 he got as a loan from the bank to buy land. The total cost of land he paid was$1,500,000. He used the financial leverage to control the $1,500,000 of the property with only $500,000 of his own money. He pays 10 percent interest per year.
Profitability Value
This is a ratio that measures the aptitude of the business to its capability to derive returns or profits from selling goods (French, 1998). The ratio is always in return to sales. They are of two types.
Gross profit margin which measures the capacity the business has to regulate the cost of goods sold expenses. It can also be used to measure the ability of the business to convert the sales into profits. To calculatethe margin, we take gross profit divide by total sales times 100 percent
Profit margin
This is a ratio which shows the capability of the business to regulate its operating expenses. The ratio also can be used by the business to measure their ability to create returns to their shareholders. It is calculated as operating profit or earnings before tax and interest divide by total sales times 100 percent.
Example: XYZ Company had made the following transactions: Sales$ 2,000,000, opening inventory $300,000, Purchases $1,000,000, closing inventory, $200,000, salaries $150,000, rent $200,000, office operating expenses $250,000.
From the above information we get gross profit margin = Sales $2,000,000 less Cost of Sales (Opening Inventory $300,000 + Purchases $1,000,000 - Closing Inventory $200,000) = 900,000
900,000/2,000,000 x 100% = 45%
Profit Margin = Gross Profit $900,000 -Operating expenses (Salaries $150,000 + Rent $200,000 + Other Expenses $250,000) = $900,000 - $600,000 = $200,000
200,000/2,000,000 x 100,000 = 10%
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Question: Explain why they are important in a health care organization: Current ratio Total asset turnover Debt ratio Profit margins Include a minimum of 2 references.
Solution:
Current ratio
This is a proportion the business use to measure how many times the current obligations can be paid from current assets before they are exhausted. Current assets are resources the business expect to translate into cash in a year whereas current liabilities represents obligations that must be meet in a cash when they fall due. Suitability of this can be contingent to the characteristics of the business industry and the structure of the current assets. Current assets should be greater than current liabilities and is usually recommended to be 2: 1.
It is very importance to health care organization because it help them to know whether their aptitude will meet their short term commitments can be achieved and immediately when they fall due.
Total asset turnover
This is a competence ratio which shows the business capability to make its revenue from the assets by relating to net sales with the average assets (Ryan, 1998).
The ratio is important to the hospital because it show how revenue they get from the patients is being generated by the available assets they have. It will help them to see if they are making good use of their available assets.
Debt ratio
This is a ratio that helps the business to measure the extent to which it can leverage. It can also be expressed as share of business assets to financed debt.
This helps the hospital to measure its capacity to pay back the debt as and when due (Ryan, 1998).
Profit margins.
These measures the ability the businesses has to control the cost of service expenses (Marks, 1998). Calculating gross profit margin, we take gross income divide by total revenue times 100 percent
They can also be used to measure the ability of the health care to convert the incomes into surplus or the shows that capacity the health acre will have to make a surplus.
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