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The following figures are taken from the final accounts of Flame Ltd for 2013 - Leaving Cert Business - Question B - 2014
Question B
The following figures are taken from the final accounts of Flame Ltd for 2013. Flame Ltd 2013 € Authorised Share Capital 900,000 Issued Share Capital 450,000 Lo... show full transcript
Worked Solution & Example Answer:The following figures are taken from the final accounts of Flame Ltd for 2013 - Leaving Cert Business - Question B - 2014
Step 1
Explain the term 'Debt/Equity Ratio'.
Answer
The Debt/Equity Ratio is a financial metric that assesses a company's financial leverage by comparing its total liabilities to its shareholders' equity. In essence, it indicates the proportion of debt financing relative to equity financing in the capital structure of the business. A higher ratio signifies more debt relative to equity, which may suggest increased financial risk, whereas a lower ratio implies a more conservative approach to financing.
Step 2
Calculate the Debt/Equity Ratio for 2013. Show your workings.
Answer
To calculate the Debt/Equity Ratio for Flame Ltd, we need to identify the total debt and total equity.
Total Debt:
Long Term Loan = €200,000
Total Equity:
Issued Share Capital + Retained Earnings = €450,000 + €150,000 = €600,000
The formula for Debt/Equity Ratio is given by: ext{Debt/Equity Ratio} = rac{ ext{Total Debt}}{ ext{Total Equity}}
Substituting the values: ext{Debt/Equity Ratio} = rac{200,000}{600,000} = rac{1}{3}
Therefore, the Debt/Equity Ratio for 2013 is 1:3.
Step 3
Discuss the importance of the Debt/Equity Ratio when deciding on new sources of finance for Flame Ltd.
Answer
The Debt/Equity Ratio plays a crucial role in financial decision-making, particularly when seeking new sources of financing. For Flame Ltd, understanding its ratio is vital as it reflects the company's financial risk and its capacity to take on additional debt.
A lower ratio indicates that the company has more equity than debt, which generally allows it to raise further capital through loans without exceeding its financial limits. Conversely, if the ratio is high, it may deter lenders from providing additional loans due to perceived risks of over-leverage.
Moreover, maintaining an optimal Debt/Equity Ratio can enhance the company's appeal to investors and lenders alike. It signals that Flame Ltd is balancing its financing sources efficiently, fostering confidence among stakeholders regarding its financial health and stability.