Solvency and Liquidity Analysis — Practice Questions

By Kenneth Boyd, Kate Mooney

If you want to know whether a company can pay its current liabilities, you need to look at a special ratio called its current cash debt coverage. The following practice questions ask you to calculate this ratio for two different companies.

Practice questions

  1. Trendy Royal Coaches has these comparative balance sheets:

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    From the statement of cash flows, cash provided by operating activities was $350 in 2015 and $270 in 2014. Calculate current cash debt coverage for 2015.

  2. Closet Queen Organizers has the following financial statements:

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    Selected information from the 2015 financial statements:

    • Interest expense: $8

    • Tax expense: $10

    • Net income: $20

    • Cash dividends paid: $164

    • Capital expenditures: $310

    • Net cash provided by operating activities: $35

    Calculate cash debt coverage for 2015 and interpret the ratio as compared to a competitor’s ratio of .17.

Answers and explanations

  1. 6.36

    Current cash debt coverage assesses the ability of the company to pay its current liabilities. The formula is cash provided by operating activities divided by average current liabilities.

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  2. .099; a lower cash debt coverage ratio indicates a company with a weaker solvency position

    You calculate cash debt coverage by dividing net cash from operating activities by average total liabilities.

    image3.png

    Closet Queen Organizers has a lower cash debt coverage ratio than its competitor, which suggests weaker solvency.

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