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Memorandum Notes

LPC Law Notes > Finance and Capital Markets Notes

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Banking Work Shop 2

Memorandum (a) What does the ratio set out at Clause 20.1(a) seek to achieve? Why might this ratio not completely address Danton's concerns?

20.1(a) The ratio of Current Assets to Current Liabilities will not at any time be less than 1.5 to 1 (1.5:1) Answer: This is the Current Ratio. It is a liquidity measure and a direct comparison of current assets with current liabilities. It measures the assets which can be turned into cash relatively readily in order to meet liabilities as they fall due. The result is expressed as a ratio: __Current assets__ : 1 Current liabilities A ratio of 1.5:1 would mean that the business has exactly PS1.5 of current assets with which to meet every PS1 of current liabilities. Most business would expect to have a higher ratio, say

1.5:1.On the other hand low current ratio means that company is at high risk of iliquidity and is unable to fulfil its financial obligation which again is considered to be the negative point of the company. Weaknesses: It does not give the most accurate and precise idea of firm's liquidity or financial position as a firm may be in trouble because of the more stock and operations that cannot be converted in cash in a small period of time. Valuation of the current assets is also an issue in calculating the current ratio as the figure of the current ratio can be easily manipulated by overvaluing the current assets of the firm.
- It does not tell anything about the profitability of the company. It does not indicate whether the production cost is high and it may result in incurring a loss to the company.
- Writing down, Bad debts and depreciation of assetsare not taken into account. An acid ratio may be more accurate as the stock prepaid debts and current work will be removed from the equation.
- The formula of the current ratio is not applicable to the seasonal products and hence does not give a clear idea of the product performance throughout the year. Another limitation of the current ratio is that it is calculated on the figures of current assets and liabilities taken from the balance sheet. There is a continuous threat that these figures may be out dated and will not calculate the current ratio accurately regarding a specific time period. (b) What does the ratio set out at Clause 20.1(b) seek to achieve? How might Danton obtain a more accurate reflection of the Group's position? And

20.1(b) the ratio of PBIT to Net Interest Payable for any Relevant Period will not be less than 4 to 1 (4:1) Answer: This is an Interest Cover Ratio. This is a ratio. Good indicator of how the company is doing. It is used to assess a company's financial durability by examining whether it is at least profitably enough to pay off its interest expenses. A ratio greater than 1 indicates that the company has more than enough interest coverage to pay off its interest expenses; as a result, the lower the interest coverage ratio, the higher the company's debt burden and the greater the possibility of bankruptcy or default. While this ratio is a very easy way to assess

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