SOLVENCY

News:

RBI Imposes Penalty on Amazon Pay: The Reserve Bank of India has
levied a ₹3.06 crore penalty on Amazon Pay for non-compliance with
certain regulatory norms. This action underscores the importance of
adherence to financial regulations by digital payment platforms
operating in the country.
Diluted Earnings Per Share (Diluted EPS) considers:
a) Only common shares outstanding
b) Only preferred shares
c) The potential dilution from convertible securities,
stock options, and warrants
d) Only retained earnings
Which of the following is included in the calculation
of diluted EPS?
a) Convertible bonds
b) Stock options and warrants
c) Convertible preferred shares
d) All of the above
Diluted EPS is always:
a) Greater than or equal to basic EPS
b) Less than or equal to basic EPS
c) Equal to net profit
d) Higher than net profit
Which of the following could cause a reduction in Diluted EPS?
a) Stock buybacks
b) Issue of new common shares
c) Conversion of convertible bonds into equity
d) Increase in retained earnings
If a company has a basic EPS of ₹5 and a diluted EPS of ₹4.50,
what does this indicate?
a) The company has no potential dilutive securities
b) The company's earnings have increased
c) The company's earnings per share would decrease if all
potential dilutive securities were converted
d) The company is experiencing losses
Which financial statement reports Diluted EPS?
a) Balance Sheet
b) Statement of Cash Flows
c) Income Statement
d) Statement of Changes in Equity
Why is Diluted EPS considered a more conservative
measure than Basic EPS?
a) It assumes the worst-case scenario where all convertible
securities are exercised
b) It ignores potential dilution from securities
c) It always results in a higher EPS
d) It excludes stock options and convertible bonds
If a company has no convertible securities, stock options, or warrants,
its diluted EPS will be:
a) Higher than basic EPS
b) Lower than basic EPS
c) Equal to basic EPS
d) Negative
Which of the following is NOT considered a potential dilutive
security?
a) Stock warrants
b) Convertible bonds
c) Common stock dividends
d) Employee stock options
 Solvency
Safety of
‘Repayment’
Fund Providers ‘interest’
of their capital
payments

• These ratios are calculated to determine the ability of the business to service
its debt in the long run.
Liquidity Vs. Solvency

Liquidity Solvency
Whether enough
Whether CA can
Assets, to pay off
pay off CL?
Long term loans?

Long – term basis

Short – term
(more than a
basis (a year)
year)
1.) Debt – equity ratio
• Meaning
Establishes the relationship b/w long term debts and shareholder’s funds
used in financing the firm’s assets

• Objective
To measure the proportion of debt and equity in the firm

• Formula
Long – term debts (Outsider Funds)
Shareholder funds (Insider Funds)
Poll
• The company is having the following items on the liability side of the
balance sheet in the FY 2019 (in Rs. ‘000).
• Equity share capital = 1000, redeemable preference share capital =
800, long term loans = 400, debts = 200 and reserves = 100.
• The ‘total debt’ of the company is:
a) Rs. 1400
b) Rs. 1200
c) Rs. 1300
d) Rs. 1500
Interpretation
• Ratio less than 1 i.e. reflects the low – debt equity ratio.
• This shows more security available to creditors.
• This also implies a more financially stable business.
• Companies with low – debt equity ratio are less risky to creditors.
• Ratio greater than 1 i.e. reflects the high – debt equity ratio
• This shows that company has raised more debt compared to equity to buy its’
assets.
• More debt means that the company is highly leveraged.
• The company is taking advantage of trading on equity.
• Companies with a higher debt to equity ratio are considered more risky to
creditors and investors
2.) Proprietary ratio or equity ratio
• Meaning
Establishes the relationship b/w shareholder funds to total assets in the
company.

• Formula
Shareholder Funds *100
Total assets
 Interpretation
• The proprietary ratio shows the contribution of shareholders in total
capital of the company.

• A high ratio indicates a strong financial position of the company and

greater security for creditors.

• A low ratio proprietary indicates that the company is already heavily

depending on debts for its operations.

• A large portion of debts in the total capital increases interest expenses

and also the risk of bankruptcy.
3.) Interest Coverage ratio
 ICR of Marico
• The EBIT of Marico is 1468 Crores rupees.
• The total interest to be paid by the company is 50
crores rupees.

ICR = 1468
50
29.36 times
Poll
• The earnings before interest and tax is $1000. The company has paid
interest on loan $400 and taxes of $700.
• The interest coverage ratio of the company is:
a) 3.4 times
b) 4.2 times
c) 2.5 times
d) 4 times
Interpretation
• This ratio is expressed in times.

• It indicates number of times interest is covered by profits available to

pay interest charges.

• Long term creditors are interested in knowing the company’ ability to

pay interest charges.

• Higher the ratio, more safety available to creditors.

 Problem Solving
• Calculate and interpret the ‘interest coverage ratio’ from the following
information of the company.
• Net profit after tax = 500,000
• 10% long – term loan = 200,000
• 10% debentures = 100,000
• Tax amount = 40000
Debt Ratio
• A company's debt ratio can be calculated by dividing total debt by
total assets. A debt ratio of greater than 1.0 or 100% means a
company has more debt than assets while a debt ratio of less than
100% indicates that a company has more assets than debt.
 MEANING OF LEVERAGE
leverage refers to the use of a significant amount of debt and/or credit to
purchase an asset, operate a company, acquire another company, etc.

Generally the cost of borrowed money is much less than the cost of
obtaining additional stockholders' equity. As a result, it is usually wise for a
corporation to use some debt and leverage.

Perhaps this is one of the reasons that leverage is also known as trading on
equity.
LEVERAGE TYPES
It measures the degree to which a firm or project can increase
operating income by increasing revenue. A business that
generates sales with a high gross margin and low variable costs has
high operating leverage.

The higher the degree of operating leverage, the greater the potential
danger from forecasting risk, in which a relatively small error in
forecasting sales can be magnified into large errors in cash flow
projections.
A high operating leverage leads to change operating income
heavily which would create low or negative profit in adverse
business situation.

Resource Video link:

https://www.youtube.com/watch?v=bZpB-o3cwp8
leverage refers to furnish the ability to use
fixed cost assets or funds to increase the return
to its shareholders.
What is Fixed and Variable cost?
News:
Chemring and John Wood Group Potential Takeovers
British engineering firms Chemring and John Wood Group are facing potential
takeovers by foreign investors, continuing a trend of corporate departures
from London's stock market.

Starbucks to Cut 1,100 Corporate Jobs and Streamline Menu

Starbucks has announced plans to reduce its corporate workforce by 1,100
positions and remove 13 drinks from its menu. This initiative, led by CEO
Brian Niccol, aims to enhance operational efficiency and focus on customer
experience.
Operating leverage measures the impact of changes
in:
a) Fixed costs on net profit
b) Variable costs on net profit
c) Sales revenue on operating income
d) Interest expenses on net profit
Which of the following correctly defines Operating Leverage?
a) The extent to which a firm's cost structure is composed of fixed
costs
b) The ability of a firm to meet its short-term obligations
c) The ratio of net profit to total assets
d) The use of borrowed funds to increase profitability
A company with low operating leverage is
characterized by:
a) High fixed costs and low variable costs
b) High variable costs and low fixed costs
c) No fixed costs
d) No variable costs
Operating leverage is calculated using
which of the following formulas?
a) Contribution Margin / Operating Income
b) Net Profit / Sales Revenue
c) Fixed Assets / Total Assets
d) Current Assets / Current Liabilities
Q1.
A Company produces and sells 15,000 shirts. The selling price per shirt
is Rs. 400. Variable cost is Rs. 200 per shirt and fixed operating cost is
Rs. 20,00,000. What will be the operating leverage?
a) 1 time
b) 2 time
c) 3 time
d) 4 time
Solution-
`

Sales Revenue (15,000 × 500) 60,00,000

Less: Variable Cost (15,000 × 200) 30,00,000

Contribution 30,00,000

Less: Fixed Cost 20,00,000

EBIT 10,00,000
Operating Leverage = Contribution / EBIT = 30,00,0000/10,00,000 = 3
times
Calculate operating leverage:
DEGREE OF OPERATING LEVERAGE
Q3. Given Sales Rs.100 million, Variable cost Rs.40 Million and
Fixed Cost Rs.40 Million. What will be the Operating Leverage?
a) 4 times
b) 3 times
c) 2 times
d) 1 time
 News:
Dow Jones Expands AI Content Licensing Marketplace: Dow Jones
has significantly expanded its AI marketplace, enabling nearly 5,000
publishers to license their content to corporations through its
subsidiary, Factiva.

Saks Global Reduces Workforce Post-Acquisition: Following its

acquisition of Neiman Marcus, Saks Global plans to cut
approximately 150 corporate jobs, representing about 5% of its U.S.
corporate workforce. This move aims to streamline operations and
integrate the newly acquired business.
Q3. Given Sales Rs.100 million, Variable cost Rs.40 Million and
Fixed Cost Rs.40 Million. What will be Operating Leverage?

a) 4 times
b) 3 times
c) 2 times
d) 1 time
If a company has a high degree of operating leverage, it
implies that:
a) A small change in sales leads to a large change in EBIT
b) The company has high variable costs compared to fixed
costs
c) The company has low business risk
d) The company’s break-even point is lower
A company has Sales of ₹500,000, Variable Costs of ₹300,000, and
Fixed Costs of ₹100,000. What is the Operating Leverage?
a) 1.25
b) 2.00
c) 1.50
d) 3.00
A firm with a degree of operating leverage (DOL) of 3.5 will experience a
_______% change in EBIT if sales increase by 10%.
a) 10%
b) 35%
c) 3.5%
d) 350%
Q2.
Financial leverage
Degree of Financial leverage
Calculate Financial Leverage
 Combined Leverage
Refers to high profits due to fixed costs.
It includes fixed operating expenses with fixed financial expenses. It indicates leverage benefits and risks which
are in fixed quantity.
Competitive firms choose high level of degree of combined leverage whereas conservative firms choose lower
level of degree of combined leverage.
Degree of combined leverage indicates benefits and risks involved in this particular leverage.

The formula which is used to calculate this is as follows-

Degree of combined leverage = Degree of operating leverage * Degree of financial leverage.

Degree of Combined leverage
A firm’s details are as under: Sales (@100 per unit) Rs. 20,00,000
Variable Cost 50% Fixed Cost Rs. 5,00,000 It has borrowed Rs.
10,00,000 @ 10% p.a. and its equity share capital is Rs. 10,00,000 (Rs.
100 each)
CALCULATE: (a) Operating Leverage(b) Financial Leverage (c) Combined
Leverage
If Degree of Operating Leverage is 4 and Degree of Financial Leverage is 2.
What will be the Degree of Combined Leverage?
a) 2 times
b) 4 times
c) 8 times
d) 6 times
If Degree of Operating Leverage is 4 and Degree of Financial Leverage is 2.
What will be the Degree of Combined Leverage?
a) 2 times
b) 4 times
c) 8 times
d) 6 times
If the total fixed cost is Rs. 15,000; selling price Rs. 25 per unit and variable cost Rs. 10 per unit.
What will be the contribution per unit?
a) Rs. 5
b) Rs. 20
c) Rs. 10
d) Rs. 15
If the total fixed cost is Rs. 15,000; selling price Rs. 30 per unit and variable cost Rs. 10 per unit.
What will be the contribution per unit?
a) Rs. 30
b) Rs. 20
c) Rs. 10
d) Rs. 40
If the total fixed cost is Rs. 15,000; selling price Rs. 30 per unit and variable cost Rs. 10 per unit.
What will be the contribution per unit?
a) Rs. 30
b) Rs. 20
c) Rs. 10
d) Rs. 40
A company reports sales = Rs. 15,000; variable cost = Rs. 8,000 and fixed cost = Rs. 2,000.
What will shall be the amount of profit?
a) Rs. 15,000
b) Rs. 8,000
c) Rs. 5,000
d) Rs. 2,000
A company reports sales = Rs. 15,000; variable cost = Rs. 8,000 and fixed cost = Rs. 2,000.
What will shall be the amount of profit?
a) Rs. 15,000
b) Rs. 8,000
c) Rs. 5,000 [15000-8000-2000]
d) Rs. 2,000
Long term solvency Analysis
• The Long term solvency position of RIL is sound for two reasons:
• First, it has a satisfactory level of interest coverage ratio during all the 8 years, being in the impressive range of 7.17 to
22.36. It is not likely to commit default in payment of interest to its lenders as its operating profits (EBIT) have incredible
margins to meet its interest obligations.
• Secondly, its various capital structure ratios have shown a substantial decrease over the years. For instance, its total
debt to equity ratio has shown a notable decrease from 0.57 in 2005 to 0.43 by 2012.
• Likewise, long-term debt to equity ratio has registered a substantial decrease from 0.49 in 2005 to 0.36 by 2012
• To conclude, Long term solvency position of RIL is sound. It enjoys very high credit rating among international credit
rating agencies as well as domestic ones.
Nifty companies interest coverage ratio falls to six-year low
• The fall was steeper on a quarterly basis. The ratio was at a 13-quarter low of 1.8 in
the March 2020 quarter. It was at 3.9 a quarter ago. The contraction was on account
of a steady rise in borrowings, which kept the interest payments buoyant despite
falling lending rates in the economy, and a sharp drop in the operating profit (EBIT)
during the quarter as companies went into a lockdown beginning from the last week
of March to contain the COVID-19 spread. The interest expense of the sample
increased by 15.6% while EBIT dropped by 52% year-on-year in the March 2020
quarter.

https://economictimes.indiatimes.com/markets/stocks/news/nifty-companies-ability-to-
service-debt-comes-under-pressure/articleshow/76623811.cms
Problem solving
• From the following information, calculate the:
a)Debt – equity ratio
b)Proprietary ratio
• Equity share capital = 400,000
• Reserves and surplus = 100,000
• Long term borrowings = 150,000
• Current liabilities = 50,000
• Fixed assets = 400,000
• Investments = 100,000
• Current assets = 200,000