1. Ratio Analysis Example Exercise 1-8 Wall Street
The financial statements shown in the previous example exercises are useful to bankers, creditors, and others in analyzing and interpreting the financial performance and condition of a company. To more effectively compare years or other companies within an industry, ratios that compare various financial performance comparison are utilized.

2. Example Exercise 1-8 Ratio of Liabilities to Stockholders’ Equity
In this Example Exercise, we will look at a specific analytical tool, the ratio of liabilities to stockholders’ equity. It is useful when analyzing a company’s ability to pay its creditors. In part (a), we are asked to compute [CLICK] the ratio of liabilities to stockholders’ equity.

3. Total Stockholders’ Equity
Example Exercise 1-8
Ratio of Liabilities to Stockholders’ Equity
Ratio of Liabilities to Stockholders’ Equity =
Total Liabilities
Total Stockholders’ Equity
The ratio takes total liabilities and divides that number by the total stockholders’ equity.

4. Example Exercise 1-8 Ratio of Liabilities to Stockholders’ Equity
Hawthorne Company’s balance sheet shows liabilities and stockholders’ equity for two years [CLICK] 4

5. Example Exercise 1-8 Ratio of Liabilities to Stockholders’ Equity (a)
$120,000
$80,000 = =
2012
Calculating the 2012 ratio takes total liabilities of $120,000 and divides this amount by $80,000. The ratio of total liabilities to total stockholders’ equity is 1.5 [CLICK]. As discussed in the text, the rights of creditors to business assets comes before the rights of the stockholders. So, the lower the ratio of liabilities to stockholders’ equity, the better able a company can withstand poor business conditions and pay its obligations to its creditors.

6. Example Exercise 1-8 Ratio of Liabilities to Stockholders’ Equity (a)
$105,000
$75,000 = =
2011
Now, to provide some perspective on Hawthorne Company’s ratio from one year to the next, let’s calculate the ratio for Again we take total liabilities of $105,000 and divide this amount by the stockholders’ equity of $75,000. In 2011, the ratio of total liabilities to total stockholders’ equity is 1.4. [CLICK]

7. Example Exercise 1-8 Ratio of Liabilities to Stockholders’ Equity
Part (b) [CLICK] asks if the creditors’ risk increased or decreased from 2011 to 2012.

8. Example Exercise 1-8 Ratio of Liabilities to Stockholders’ Equity (b)
Comparing the two years, Hawthorne had a slightly higher ratio of total liabilities to stockholders’ equity in 2011; therefore, the creditors’ risk have [CLICK] increased.
INCREASED!

9. Example Exercise 1-8  For Practice: PE 1-8A, PE 1-8B
For additional practice with this ratio go to Practice Exercises 1-8A and 1-8B.
 For Practice: PE 1-8A, PE 1-8B