Two businesses, Brown Bag Corp. and April Sales Co., have sought business loans from you.

Two businesses, Brown Bag Corp. and April Sales Co., have sought business loans from you. To decide whether to make the loans, you have requested their balance sheets.

Requirement

1. Using only these balance sheets, to which entity would you, be more comfortable lending money? Explain fully, citing specific items and amounts from the respective balance sheets.(Challenge)

Debt –equity ratio: 

The relationship between debts and equity of a company is explained with the financial ratio called debt-equity ratio. This ratio helps in determining the mix of various financing options available for a company. This could be used to determine whether to invest in that company by a potential investor.

Calculate the debt-equity ratio as shown below: 

Therefore, the debt-equity ratio of BB Corp is 6.50 whereas, for AS Corp, it is 0.30.

 

 Liquidity position: 

The ratio of current assets to current liabilities depicts the liquidity position of a company. This could be used to determine the working capital requirements of the company.

 

Calculate the current ratio as shown below: 

 

The current ratio of BB Corp is 0.30 and for AS Corp is 2.00. This clearly indicates the liquidity position of AS Corp is much better than BB Corp. The current ratio of BB Corp is less than the ideal ratio of 1.

Conclusion:  

It is better to lend money to AS Co., as it has a better debt-equity ratio and current ratio when compared to BB corp’s.