Question

The person in charge of the finances of the company MGT, S.A. wants to know the company's situation concerning the industrial sector to which it belongs. For this, it has the following information regarding the industry:

1. General liquidity ratio is 1.55; the acid test is 1.20, and the ratio between the available and the current liabilities is 0.95.
2. The debt ratio stands at 1.25. The margin on sales is 21%. The investment rotation is 1.45 times.
3. Economic profitability is around 23%, and financial profitability is 29%

The data referred to the company (in thousands of €) are the following:

Assets		Liability and Net Equity
Non-current asset (net)	170	Equity	125
Stocks of finished products	45	Reservations	25
Clients	65	External Resources	105
Banks	70	Loans	65
		Supplier	30
Total Assets	350	Total Net Equity	350

In addition, it is known that:

• Sales are € 250,000 and its direct cost of € 105,000.
• Amortization of € 70,000.
• Long-term debt generates interest at 5%, short-term bank loans at 7%, and the departure of suppliers does not accrue any interest.
• The Corporation Tax is 25%.

The question is : I cannot calculate the Debt ratio, as debt ratio = total debt / total asset... but i am not sure why in the balance sheet, the debt/ asset ( 105+65)/350= 0,48 ., is really smaller than the sector. Am I wrong?

Answer 1

There are two formulas we can use to calculate debt ratio

1) Debt Ratio = Total debt / Total assets

2) Debt ratio = Total assets / Total liabilities

As the debt ratio in general for above given sector is 1.25 and if we use first formula then the ratio would be maximum 1 or less than 1. So, i believe that the formula used to calculate debt ratio in above example is second formula which will be as follows

Debt ratio = Total assets / Total liabilities

Debt ratio = 350 / (350 - 125)

Debt ratio = 1.56

The above debt ratio looks relevant to the sector.

Total liabilities = Total asset - Equity