Agriculture Reference
In-Depth Information
For most fi rms a quick ratio between 0.8 and 1.0 signifi es suffi cient strength in liquidity.
Consequently, at fi rst glance BF&G would appear to have adequate liquidity. However, the
ratio would need to be monitored because any diffi culty in collecting accounts receivable
could cause problems. This ratio is of great interest to lenders of short-term funds. These
funds may be needed because any change in value for marketable securities and for accounts
receivable could result in their immediate cash values being lower than the ratio indicates.
A new or rapidly growing fi rm with immediate cash needs for labor, supplies, and goods
must be more aware of this ratio than older, more established businesses. The ease of
converting inventory to cash must also be considered. It is possible for a fi rm to be making
a profi t, and have a strong owner's equity position in relation to total assets, and still be so
starved for available cash that it is unable to take advantage of discounts or quantity
buying, meet emergencies, or even pay current bills. Bankruptcy results when a fi rm is
unable to pay its bills as they come due, so the liquidity area is one of fundamental con-
cern for agribusiness managers.
Solvency ratios
A third challenge to management is keeping the fi rm solvent. Solvency is related primarily
to a fi rm's ability to meet all of its claims over the long-run or total liabilities.
Solvency
ratios
pinpoint the portions of a business's capital requirements that are being furnished by
owners and by lenders. Evaluation of solvency ratios gives an indication of the likelihood
that lenders will incur problems in recovering their money. These ratios can have a real
effect on the amount of long-term money a fi rm can borrow and affect alternative sources
of outside capital. If creditors supply a greater portion of the total business capital, and,
thus, assume a greater share of the risk, they normally would demand more fi nancial docu-
mentation and would more closely monitor management's decisions. These ratios can also
indicate when a fi rm should consider borrowing more of its capital needs, with consequent
opportunity for increasing return on its own investment.
Debt-to-equity ratio
:
total liabilities divided by owner's equity
. This ratio (Equation 9)
indicates the relationship of BF&G's owner's equity to the total liabilities of the fi rm:
Total Liabilities
/
Owner's Equity
=
Debt-to-Equity Ratio
(9)
$,
02 3 665 82
From Balance Sheet ll and qq
31
,
000
/ $,
,
000
=
0
.
(
)
,
In the case of BF&G, we fi nd a ratio of 0.82 to 1, or total liabilities that are equal to
82.0 percent of owner equity. Interpreted another way, this ratio suggests that for every
$1.00 of owner investment in BF&G, there is 82 cents of outsider investment. Lenders
tend to get nervous when their investment is greater than that of owners, which would
result in a debt-to-equity ratio greater than 1.0.
Here we can see the ownership interest in contrast to the creditor interest in the fi rm.
Some lenders require the 1:1 ratio mentioned above as the absolute upper limit. Changes
in this ratio over a period of time can be of great signifi cance in planning long-range
fi nancial programs for BF&G. As BF&G is able to continue generating healthy sol-
vency fi gures, lenders may begin viewing the fi rm as a good credit risk and offer “pre-
ferred customer” status and, potentially lower interest rates.
