Page 198 - Calculating Agriculture Cover 20191124 STUDENT - A

21-10 Profitability & Performance Measures CH 21]

Example A: Calculate the Equity Ratio for the Dunbar Cattle Company, Figure 21.1.

Solution algorithm:
Total Equity
Equity Ratio = ——————- Note: 0.26 x 100 : 1 x 100 =
Total Assets
26 : 100
$261,200
Equity Ratio = —————
$989,400

= 0.26 = 0.26 : 1 = 26 : 100

This ratio indicates a rather strong equity position with very little debt against assets.
Should this Equity to Asset ratio be 1:1, it would indicate that Dunbar Cattle Company has
zero debt.

Debt to Equity Ratio. A liquidity ratio that compares a company’s total debt to total
equity. The debt to equity ratio determines the percentage of company financing that comes
from creditors and investors. A low debt to equity ratio is preferred as a higher debt to
equity ratio indicates more creditor financing (bank loans) is used than investor financing
(shareholders).
The debt to equity ratio is calculated by dividing total liabilities by total equity. The debt
to equity ratio is another balance sheet ratio since all of the elements are reported on the
balance sheet.
Total Liabilities
Debt to Equity Ratio = ———————-
Total Equity

Example A: Calculate the Debt to Equity Ratio for the Dunbar Cattle Company, Figure
21.1.

Solution algorithm:
Total Liabilities
Debt to Equity Ratio = ———————-
Total Equity
$728,200
Debt to Equity Ratio = —————
$261,200

= 2.79 = 2.79 : 1

This calculation is a validation of the previous analysis of Dunbar Cattle Company debt
status. Looking at the Dunbar Balance Sheet, with Accounts Payable at $129,600, which
could represent wages due, or inventory in trade that as yet needs to be paid for, and is paid
for with sales. Notes payable are for working assets, which could include machinery,
equipment, vehicles and like items. The time on this debt is from 18 months and no longer
than 7 years. The mortgage payable of $300,000 represents real estate along with the
buildings and property improvements (roads, fences, water and sewage systems). The fixed
asset value is $227,400 and the liability against fixed assets is $300,000 which indicates
that Accounts Receivables ($324,000) must be collected and Inventory ($300,000) could be
reduced through sale to reduce Notes Payable ($270,000) and reduce Mortgage Payable
($300,000).

Profitability and Profitability Ratios
The primary goal of any business is to make a profit. Profitability ratios are derived from
the firm’s income statements and show the firm’s ability to generate profits in its market
serving its target customers from its operations. Profitability ratios bring a focus to the
return on investment in a firm. These ratios show how well the firm can achieve profits from
its operations.
Investors and creditors use profitability ratios to evaluate the firms’ return on
investment based on its relative level of resources and assets. These ratios relate to a firm’s
efficiency to generate profits, and is indicative of its solvency. Solvency being the ability of
the firm to pay its debts.

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