Assignment: The Balance Sheet and Credit Risk Analysis
Credit risk encompasses a company's ability to meet its obligations as they arise as well as a long-run ability to pay its debt. A company may be profitable but yet face bankruptcy if it is unable to pay its liabilities on time. Companies with large amounts of debt have greater credit risk because of an increased vulnerability to increases in interest rates and declines in profitability.
In this assignment, you will answer questions about your company's classified balance sheet and conduct a ratio analysis to evaluate the company's liquidity and solvency. A financial ratio expresses the relationship of one amount to another and enables analysts to quickly assess a company's financial strength, profitability, or other aspects of its financial activities.
Requirements
In the first section, define liabilities and describe how liabilities are classified as current and long-term (give examples). Also define liquidity and solvency as it relates to the company's debt-paying ability. What does your company call its ‘Balance Sheet'?
In the second section, define working capital, the current ratio, and the debt ratio, three frequently used ratios to assess credit risk (described in LEO's online text or any principles of accounting text). Identify which are a measure of liquidity and which are a measure of solvency. Indicate how the ratio is interpreted. Is an increasing or decreasing ratio a favorable trend? Conduct online research to provide a ratio level (or range) that is considered acceptable for the current and debt ratio (technically, working capital is not a ratio so an average isn't meaningful). If you can find information on acceptable ranges for the current ratio and debt ratio for your company's industry, include that in your discussion.
Numbers and ratios are more meaningful when considered relative to a benchmark. Benchmarks can be the company's past performance, a similar company's performance, an industry average, or a rule-ofthumb. For instance, for decades, a current ratio of 2 to 1 was considered satisfactory. In the third section, prepare a table giving the dollar amount of current and long-term liabilities for the most recent year and the previous year. Either in the same table or a new table report the results of a ratio analysis. Calculate working capital, current ratio, and the debt ratio for the current year and the past year (show your calculations). Indicate whether the ratios are improving or deteriorating. If you find a relevant benchmark (industry average or rule-of-thumb), comment on your company's performance relative to the benchmark.
Finally, in the fourth section briefly summarize results of any or all of the following: 1) an internet search for articles on recent events that may affect your company's debt paying ability, 2) an internet search for financial analysts' assessment of the company's credit risk and or 3) management's view of the company's current debt-paying ability as found in the Management Discussion and Analysis (MD&A) section of the annual report. Either in this section or a conclusion paragraph, briefly summarize the results of your credit analysis by commenting on your company's weakening or stronger financial position (i.e. liquidity and solvency).
Technical requirements same as for the first paper. Business report, single-spaced, use headings, should be over one page; limit to two pages, cite references and provide reference list. Make a table in Word (or Excel and copy into Word) as mentioned in the third section and provide appropriate and column and row labels.