Organization of the work of a modern enterprise is a complex process. To evaluate its effectiveness, information is collected and evaluated from a variety of indicators. This allows management to identify factors inhibiting development and eliminate them in the future.
However, such research is no less important for investors. The coverage ratio and a number of other indicators help them conclude that it is advisable to finance the activities of a company. Therefore, the financial and analytical service should regularly monitor the coverage or liquidity ratios in order to keep its investment rating at the top. This ensures that the company will develop harmoniously.
Liquidity concept
Liquidity indicators play an important role in the analysis of the effectiveness of money management. The data of such studies are of interest to the management of the enterprise, its founders and creditors. If the capital structure complies with all regulations, this will reflect the coverage ratio.
In the modern world, almost any company uses borrowed capital. This enables the company to develop, expand its production. But, using paid sources of financing, it will be necessary to repay some funds in the form of interest in the prescribed time. Therefore, the investor must be sure that the organization has the ability to pay off its debts with it in the short term. This is determined using the overall coverage ratio and a number of other indicators.
Determination of liquidity
Liquidity is the ability of a company to fully settle its debt arising from the use of paid sources of financing in a timely manner.
The coverage ratio (liquidity) is calculated according to the financial statements. For this, the financial analyst uses the information from Form 1 “Balance” for calculations. Current responsibility compared with the value of working capital. After all, it is at the expense of them that debts are repaid in the short term.
The coefficient of coverage of sources of formation of assets in the calculations takes into account the speed with which each item of the balance can be converted into cash. Indeed, it is in this form that the debt is repaid.
Liquidity ratio
When calculating the coverage ratio of assets, analysts take into account various items of defense capital. Each of them is distinguished by its specific speed being converted into cash. This contributes to the distribution of working capital in groups. Each of them is characterized by a certain degree of liquidity. The most quickly withdrawn are funds in accounts or at the cash desk. They are followed by securities, bank bills.
Accounts receivable are less liquid. It is followed by stocks in warehouses. The most difficult to implement are buildings and structures, as well as construction in progress. Such a ranking allows you to understand what is the probability of investors getting their funds and interest in the near future.
Capital structure
Using formulas to calculate the coverage ratio of liabilities, analysts evaluate the effectiveness of the structure of sources of balance sheet formation. They can be generally divided into own and borrowed funds. Studying coverage ratio equity current liabilities, it is possible to identify negative trends in the distribution of funding sources.Without borrowed funds, the company loses the ability to expand production.
As a result, it receives less profit in the reporting period. But, using paid additional funds in your turnover, you can significantly increase the result of your work. However, it is important to determine the maximum allowable amount of current accounts payable, which will allow you to get the highest net income. The higher the amount of borrowed capital in the balance sheet structure, the lower the investment rating. Only by correlating all these indicators, you can get the most effective structure of funding sources.
Calculation formula
Calculating the coefficients of coverage of the current debt, apply a certain formula. This allows you to evaluate how much of the assets will go to pay borrowed capital. The coverage coefficient, the formula of which is presented below, is calculated as follows:
Kp = (A - ON - KO): (DO + KO), where A is the balance sheet currency, ON is intangible assets, KO is Short-term liabilities, BEFORE - long term duties.
The regulatory value for enterprises in a particular industry is not the same. For industry, it is 2, and in the service sector - 1.5. The higher the indicator, the lower the risk of investors. But too many indicate inefficient use of capital.
Interpretation of the result
The total coverage ratio should be analyzed in the current period, as well as in dynamics. You should also know the normative value of it in the industry of the company. Therefore, a technique is used to calculate the coverage ratio of competing enterprises. The study of dynamics will highlight the development trend, as well as determine the constraints. The analysis of the indicator according to the results of the current period is compared with the standard value for the industry. If the indicator is less than recommended, this indicates a low solvency, and sometimes indicates a risk of bankruptcy.
If, during calculations, a liquidity indicator was determined equal to or slightly higher than the normative, this indicates the effective operation of capital. Solvency and investment attractiveness is high. But in the case when the ratio is much higher than the industry average, with high solvency, this indicates a low efficiency of capital management.
Balance sheet liquidity
Studying the coefficient of balance sheet coverage, it is necessary to break all its articles into groups. An asset consists of 4 categories:
- A1 - cash;
- A2 - short-term receivables;
- A3 - long-term receivables, inventories, VAT;
- A4 - non-current assets.
In the same way, it is necessary to separate the passive. He will also have 4 groups:
- P1 - payables.
- P2 - loans and borrowings.
- P3 - long-term liabilities.
- P4 - equity.
By comparing the relevant categories, you can determine whether the liquid balance. If there are deviations from the norm, management should immediately take a series of measures to eliminate adverse factors. The efficiency of the enterprise depends on this.
Balance sheet liquidity analysis
Analyzing the performance of coverage, you should consider the balance sheet in the context of its structure. This will allow the financial manager to understand what factors cause deviations of the standard, if any.
If all the indicators are in the required proportions, you can find ways to improve their structure, even in the absence of deviations.
- The first comparison looks like A1> P1. Its implementation indicates the ability of the enterprise to repay its most urgent obligations at the expense of cash.
- A2> P2 indicates the ability to cover loans and borrowings at the expense of quickly sold assets.
- A3> P3 indicates the ability to find resources to pay off long-term obligations.
- But A4 should be less than or equal to P4. If the above inequalities are observed, this condition is satisfied automatically.
Calculation of coverage ratio
To calculate the coverage ratio, it is necessary to take the balance sheet results for the reporting period as a basis. According to his articles, the calculation will have the following form:
Kp = s.1200: (s.1520 + s.1510 + s.1550).
The data are compared in dynamics and with an intra-industry indicator. However, this does not give a complete picture. Therefore, along with the general liquidity, a number of partial ratios are calculated. Also a financial analyst can calculate net working capital to look at the situation from different angles. This will assess how much the company's own funds are in circulation. The lack of these funds indicates the inability of the organization to pay off its obligations.
Debt coverage ratio
Worldwide, financial analysts, along with liquidity indicators, calculate the debt coverage ratio. For its calculation, data are used not only of the balance sheet, but also of form 2. The profit and loss statement of the enterprise displays the amount of net income that the company received in the reporting period.
To calculate this indicator, the following formula is used:
Efficiency = BH: KO, where BH - net income.
If the result is less than 1, the company is doing poorly. Also, the analysis should be carried out in dynamics. With its decrease, it is necessary to track the factors of such changes. In case of force majeure situations, having a sufficient amount of net income, the company will be able to repay the debt in full. This is true for the short term.
Planned liquidity
The coefficient of coverage of obligations, which is considered in the future, is taken into account by investors. This allows you to assess their risks. In the short term, the company is able to pay off its debts if A1 + A2> P1 + P2, as well as A4 For the company’s management itself, this approach will make it possible to predict future development, as well as adjust this movement. But if, after analysis of the balance sheet structure, it was determined that A4> P4, the amount of funds to repay the obligations is considered insufficient. In this case, management should take immediate action to optimize coverage. Otherwise, if there is a need to urgently pay off creditors, it will not be able to do so. Having lost investor confidence, restoring your reputation will be quite difficult. Having familiarized yourself with such a financial analysis tool as a coverage ratio, you can correctly conduct studies of the company's solvency, as well as adequately interpret them. This information will allow the most correct organization of the work of capital.
