Broome County CAFR - Article Example

? BROOME COUNTY CAFR Introduction Financial Analysis is a systematic process for assessment of stability, viability and profitability of any business. The analysis is derived from the published financial statements of business organization. The most popular tool for financial analysis is derivation of financial ratios from balance sheet and income statements. Financial statement analysis provides basic information to various stakeholders regarding how well the management of the company is able to run the business. More specifically, financial statement analysis mainly focuses on the following aspects for assessing health of any firm: Financial Performance Financial Position Short Term Liquidity Long Term Solvency Financial Capacity Financial Indicator: Long Term Solvency The long term solvency of Broom County is referred to as the company’s ability to honor long term obligations. In order to assess the long term solvency of the firm there are many standard ratios available such as Debt size ratio, Debt to equity ratio, Cash flow coverage ratio, Debt service as percentage of revenues, and so on. In this study the long term solvency of Broom County was analyzed using two key ratios namely Debt size ratio and Debt equity ratio. The formulas for the respective ratios are as follows, Debt Size Ratio = Total Debt/Total Asset Debt-Equity Ratio = Total Debt/Total Net Asset In order to determine the values of the ratios, the financial statements for the year 2006 and 2007 of Broom County was analyzed and the following results were found, Interpretation Debt Size Ratio This ratio measures the degree of financial leverage of the company, and generally higher values indicate higher financial risk. The ratio indicates whether the company is in a better financial position to service its total debt with its total assets. If the value of this ratio is more than 1, then it indicates that the firm has more debt compared to its assets. This kind of scenario increases financial risk of the firm as debt capital involves service of fixed interest on outstanding liability periodically. This means that the firm will have to pay interest on outstanding debt either quarterly, or half-yearly irrespective of its earnings. So, even when the company has incurred a loss in particular fiscal year, it is liable to oblige and honor fixed liabilities. With the increased use of debt capital for financing, the magnitude of interest payable on outstanding debt increases (Megginson and Smart, 2008, p.53). The actual long term solvency would depend on the ability of the company to generate sufficient incomes from their operations so that they are able to service fixed interest payable on outstanding liability. Generally the ideal value of debt ratio should be less than 0.50. Debt Equity Ratio The Debt to Equity ratio is a measure of relative proportion of debt to shareholders’ equity that is used by the company to finance its assets. It is one of the indicators for long term solvency of a company. The two components of this ratio are derived from the balance sheet of the company that reflects the company’s financial position on a given date. The debt observed in this ratio is usually the long term debt of the organization. The composition of debt and equity in the capital structure of a firm determines influences value of firm and its long term solvency (Gibson, 2012, pp.285-286). Basically, this ratio is a measure of company’s future obligations relative in balance sheet to equity and higher values indicate that company’s long term debt exceeds shareholders’ equity. Hence, the ideal value should be less than 1. Financial Health Analysis When the balance sheet of Broom County was analyzed for the years 2006 and 2007, it was found that Debt Ratio of Governmental Activities was 50.61% and 49.06% respectively. As discussed earlier, the acceptable value of this ratio should be less than 50% and the organization seems to have deleveraged their balance sheet in the year 2007 from 2006. The value of this ratio from Business Activities for both the years are less than 50% and are hence within tolerable limits. Similarly, the financial statements for the two years were observed to determine Debt to Equity ratio and it was found that the value of this ratio was for Governmental Activities was very high, which is a matter of concern. This is derived from the concept discussion earlier which suggests that ideal value of this ratio should be less than 1. In case of Business Activities this condition is satisfied but the overall value is greater than 1 for both the years. Conclusion and Recommendations After conducting a long term solvency test on Broom County, it was found that overall the company has manageable debt proportion to its assets. However, the shareholders’ equity generated from governmental activities was found to be disproportionate to total debt and is hence a major concern. In other words, the organization should lower total debt from governmental activities so that long term solvency is not threatened. References Gibson, C. H. (2012). Financial Reporting and Analysis. 13. United States: Cengage Learning. Megginson, W. L. and Smart, S. B. (2008). Introduction to Corporate Finance. United States: Cengage Learning. Read More