To help improve our operations, comment on how we are doing with respect to asse

Question

To help improve our operations, comment on how we are doing with respect to asset management. Are there any areas for improvement?

2. To measure our company's solvency, which of these ratios would we use and why?

3. In an effort to help us improve our overall debt situation, we would like you to provide us with an assessment of our company's solvency and leverage.

Choice Hotels Ratios 2016 2015 Percent change from 2015 to 2016 Formulas Receivables turnover ratio 8.61 9.62 -0.10 receivables turnover ratio = net sales / accounts receivable Asset turnover ratio 1.08 1.20 -0.10 asset turnover ratio = net sales / average total assets Current ratio 1.31 1.49 -0.13 current ratio = current assets / current liabilities Quick ratio 1.17 1.36 -0.14 quick ratio = (cash and equivalents + accounts receivable) / current liabilities Cash ratio 0.77 0.93 -0.17 cash ratio = cash equivilants / current liabilities Debt-to-assets ratio 0.98 1.13 -0.13 debt-to-assets ratio = total debts / total assets Debt-to-equity ratio -3.74 -2.81 0.33 debt/equity ratio = total liabilities / shareholders' equity Operating profit margin 0.26 0.26 -0.01 operating profit margin = operating income / net sales Net profit margin 0.15 0.15 0.01 net profit margin = net income / net sales Return on assets (ROA) 0.16 0.18 -0.08 return on assets (ROA) = net income / total assets Return on equity (ROE) -0.45 -0.32 0.38 return on equity (ROE) = net income / shareholders' equity

Explanation / Answer

Solvency ratios, also called leverage ratios, measure 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 issues and a firm’s ability to pay its bills in the long term. Many people confuse solvency ratios with liquidity ratios. Although they both measure the ability of a company to pay off its obligations, solvency ratios focus more on the long-term sustainability of a company instead of the current liability payments.

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

As stated by Investopedia, acceptable solvency ratios vary from industry to industry. However, as a general rule of thumb, a solvency ratio higher than 20% is considered to be financially sound. Generally, a lower solvency ratio of a company reflects a higher probability of the company being on default with its debt obligations.

Different forms of solvency ratios

Generally, there are six key financial ratios used to measure the solvency of a company. These include:

Current ratio

Computed as Current Assets ÷ Current liabilities, this ratio helps in comparing current assets to current liabilities and is commonly used as a quantification of short-term solvency.

Quick ratio

Also known as ‘liquid ratio’ and computed as Cash + Accounts Receivable ÷ Current liabilities, considers only the liquid forms of current assets thus revealing the company’s reliability on inventory and other current assets to settle short-term debts.

Debt to Equity Ratio

The debt to equity ratio is a financial, liquidity ratio that compares a company’s total debt to total equity. The debt to equity ratio shows the percentage of company financing that comes from creditors and investors. A higher debt to equity ratio indicates that more creditor financing (bank loans) is used than investor financing (shareholders).

Debt to Asset Ratio

Debt ratio is a solvency ratio that measures a firm’s total liabilities as a percentage of its total assets. In a sense, the debt 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. Companies with higher levels of liabilities compared with assets are considered highly leveraged and more risky for lenders.

This helps investors and creditors analysis the overall debt burden on the company as well as the firm’s ability to pay off the debt in future, uncertain economic times.

3) As we can see most of the ratios are going negative, these means solveny and profitability is going down.

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