JBJ Antiques (JBJ) reported the following comparative income figures in 2006. Ot
ID: 2399105 • Letter: J
Question
JBJ Antiques (JBJ) reported the following comparative income figures in 2006.
Other income
Your boss, the president of Henry Bank, is concerned about JBJs borrowing capacity. A representative of JBJ feels that there should be no problem, since net profits are the same with slightly higher sales.
Required: Compute times interest earned and comment on the bank's position.
(in thousands) 2006 2005 Net Sales 701 646Other income
10 8 711 654 Cost and Expenses: Cost of goods sold 472 408 Selling and general expenses 176 156 Interest 28 22 676 586 Income before income tax and extraordinary item 35 68 Income taxes (15) (30) Income before extraordinary items 20 38 Extraoridnary items- Loss on fire 18 Net Income 20 20Explanation / Answer
Solution :Time interest ratio = EBIT ÷ Interest expense
Time interest ratio (2005) = $68 ÷ $22 = 3.09
Time interest ratio (2006) = $35 / $28 =1.25
Time interest ratio used to measure the paying ability of business to its debts. If Time interest ratio is less than 1 that means business is not in a position to meet it's interest obligation. In other words, higher the ratio, higher the ability to meet debt obligations
In the given case, the Time interest ratio has substantialy decreased from 3.09 to 1.25 which shows the decreasing ability of the JBJ to pay it's debts. However, a representative of JBJ feels that there should be no problem, since net profits are the same with slightly higher sales.
His view is not correct since, net profit is not relevent to the Time interest ratio.
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