1. CURRENT LIABILITIES INCREASED
POSITION No.2
Let the current liabilities be increased by Rs.4 lacs against increase of current assets for an equal amount, i.e. from the funds obtained from current liabilities for Rs.4.00 lacs, the company has acquired current assets for Rs.4 lacs. The resultant structural position wiil be as follows :
| (Rs. in lacs) |
| Block | 10.00 | | Paid up capital | Rs.10.00 |
| Less: Deferred liability | 2.00 | Rs. 8.00 | Reserves | 1.00 |
| Current Assets | 10.00 | | | |
| Less : Current liability | 8.00 | 2.00 | | |
| Miscellaneous Assets | | 1.00 | | |
| Tangible Net Worth | | 11.00 | | |
| | | Total | Rs. 11.00 |
On a comparison between position No.1 and 2 it is found that the tangible net worth has remained the same, yet the financial position has become weakened consequent to a fall in current ratio and enhancement of the debt:equity ratio. These ratios now are:
Current Ratio = 1.25:1
Debt:Equity Ratio = 0.90:1
The interpretation is simple in as much as that in position No.2 for every Rupee of liability becoming payable there are current assets of the order of Rs.1.25 available for meeting it whereas in position No.1 the company has 1.50 Rupees. Position No.1 may therefore be presumed to be more favourable. In the first position, total debt payable is 54 paise for every Rupee of asset held, whereas in position No.2 it is 90 paise for every Rupee. So on both counts financial position has deteriorated, in spite of the fact that the company's own worth in both cases has remained the same. We may convey the substance of these changes by stating that in between position 1 and 2 structural position of No.1 is more stronger than in No.2.
POSITION No.3
Let Current Liabilities be increased by Rs.4.00 lacs against increase of block Rs.4.00 lacs.
The break up of the balance sheet now turns into:-
| (Rs. in lacs) |
| Block | 14.00 | | Paid up capital | Rs.10.00 |
| Deferred liability | 2.00 | 12.00 | Reserves | 1.00 |
| Current Assets | 6.00 | | Tangible Net Worth | Rs. 11.00 |
| Current liabilities | 8.00 | -2.00 | | |
| Miscellaneous Assets | | 1.00 | | |
| Tangible Net Worth | | 11.00 | | |
Once again the tangible net worth has remained the same. Position No.3 has become more vulnerable than position No.(1) or (2) consequent to the advent of working capital debt. The ratios now are:
Current Ratio = 0.75:1
Debt: Equity Ratio = 0.90:1
A comparison between (2) and (3) may be noted.
The debt equity ratio has remained the same in both cases, but the current ratio has fallen from 1.25 to 0.75. Hence (3) is considered as more vulnerable than (2).
POSITION No.4
Current liabilities increased Rs.2 lacs against deferred liability decreased Rs.2.00 lacs.
The break up then would be as follows :
| (Rs. in lacs) |
| Block | 10.00 | | Paid up capital | Rs.11.00 |
| Less. Defd. Liability | | 10.00 | Reserves | 1.00 |
| Current Assets | 6.00 | nil | | |
| Less: Current liability | 6.00 | 1.00 | | |
| Miscellaneous Assets | | | | |
| Tangible Net Worth | | 11.00 | | |
| | | | 12 |
Current Ratio = 1:1
DebtiEquity Ratio = 0.54:1
Here once again the net worth remains the same i.e. Rs. 11.00 lacs. But there is no liquid working 'capital and hence the organisation remains weak. The current ratio has improved and remains at 1:1 a better position then (3) above. So also the debt equity ratio of 0.54:1 is also a better position than (3) above. Hence between (3) and (4) the former is more vulnerable than the latter.
If a comparison between (4) and (2) is made it will be found that the carrent ratio has fallen while the debt equity ratio has improved. In spite of the total debt position in (1) and (4) remaining same (4) is to be considered vulnerable, consequent to the weakened current ratio position and absence of working capital.
POSITION No.5
Current liabilities increased Rs.2.00 lacs against decrease of capital Rs.2.00 lacs.
| (Rs. in lacs) |
| Block | 10.00 | | |
| Less: Deferred liability | 2.00 | 8.00 | |
| Current Assets | 6.00 | | |
| Less:Current Liability | 6.00 | nill |
| Miscellaneous assets | | 1.00 |
| Tangible Net Worth | | 9.00 |
| Capital | | 10.00 |
| Less: Paid | | 2.00 | 8.00 |
| Reserves | | | 1.00 |
| | | 9.00 |
Here capital has been paid out of current borrowings. A liability has been created without having a compensating asset. Position is more vulnerable than (4) above.
Current Ratio = 1:1
Debt:Equity Ratio = 0.9:1
POSITION No.6
Current liabilities increased Rs.1 lac against surplus decreased for an equal amount:
| (Rs. in lacs) |
| Block | 10.00 | |
| Less: Deferred liability | 2.00 | 8.00 |
| Current Assets | 6.00 | |
| Less: Current Liability | 5.00 | 1.00 |
| Miscellaneous Assets | | 1.00 |
| | 10.00 |
| consisting of:- | | |
| Paid up capital | | 10.00 |
| Reserves | 1.00 | |
| Less: Paid | 1.00 | nil |
| Tangible Net Worth | | 10.00 |
Here reserves have been paid out by increase of current liabilities. Worth of the company is reduced from the standard position. Position therefore is worse than standard position.
Current Ratio = 1.2:1
Debt:Equity Ratio = 0.7:1
2. CURRENT LIABILITIES INCREASED
POSITION No.7
| (Rs. in lacs) |
| Block | 10.00 | |
| Less: Deferred liability | 2.00 | 8.00 |
| Current Assets | 4.00 | |
| Less: Current Liability | 2.00 | 2.00 |
| Miscellaneous Assets | | 1.00 |
| Tangible Net Worth | | 11.00 |
Here the tangible net worth has remained the same as the normal. Position, however, is better than the standard consequent to improvement of both ratios :
Current Ratio = 2:1
Debt:Equity Ratio = 0.4:1
Both the above ratios are better than the ratios of the standard balance sheet.
POSITION No.8
Current liability decreased Rs.2.00 lacs against fixed assets decreased for an equal amount:
| (Rs. in lacs) |
| Block | 8.00 | |
| Less: Deferred liability | 2.00 | 6.00 |
| Current Assets | 6.00 | |
| Less: Current Liability | 2.00 | 4.00 |
| Miscellaneous Assets | | 1.00 |
| Tangible Net Worth | | 11.00 |
Block assets are reduced and from the proceeds current liabilities are paid off. The tangible net worth even though remaining same as before, the increase in the working capitai is a very significant change :
Current Ratio = 3:1
Debt:Equity Ratio = 0.4:1
Financial position is better than the position of the standard balance sheet and even that of position 7.
POSITION No.9
Current liabilities decreased Rs.2.00 lacs against deferred liabilities increased for an equal amount:
| (Rs. in lacs) |
| Block | 10.00 | |
| Less: Deferred liability | 4.00 | 6.00 |
| Current Assets | 6.00 | 4.00 |
| Less: Current Liability | 2.00 | |
| Miscellaneous Assets | | 1.00 |
| Tangible Net Worth | | 11.00 |
Here the working capita! has remained at the same level as at (8) above. The tangible net worth has also remained stable at Rs.11.00 lacs. But the total liabilities of the company in (8) are at Rs.4.00 lacs but in (9) Rs.6.00 lacs. Hence position (9) is less favourable than position (8). This is reflected in the ratios as under:
Current Ratio = 3:1
Debt:Equity Ratio = 0.5:1
POSITION No.10
Current liabilities decreased Rs.2.00 lacs against capital increased for an equal amount:
| (Rs. in lacs) |
| Block | 10.00 | 8.00 | Capital | 12.00 |
| Less. Deferred Liability | 2.00 | | Reserves | 1.00 |
| Current Assets | 6.00 | | | 13.00 |
| Less: Current liability | 2.00 | 4.00 | | |
| Miscellaneous Assets | | 1.00 | | |
| Tangible Net Worth | | 13.00 | | |
This position is more favourable than (9) above. This may be seen from the ratios as under :
Current Ratio = 3:1
Debt.Equity Ratio = 0.3:1
Even though the current ratio has remained at the same position there is a fall in Debt:Equity ratio. In between (9) and (10) - the last one is preferable.
3. CURRENT ASSETS DECREASED
POSITION No.11
Current assets decreased Rs.2.00 lacs against fixed assets increased for an equal amount
| (Rs. in lacs) |
| Block | 12.00 | |
| Less: Deferred liability | 2.00 | |
| Current Assets | 4.00 | 10.00 |
| Less: Current Liability | 4.00 | |
| Miscellaneous Assets | | 1.00 |
| Tangible Net Worth | | 11.00 |
Even though the tangible net worth has remained at the same level at Rs.11.00 lacs the position has become vulnerable consequent to the absence of working capital.
Current Ratio = 1:1
Debt.Equity ratio = 0.5:1
The position is not better than the standard one.
POSITION No.12
Current assets decreased Rs.1 lac against fixed liabilities decreased.
| (Rs. in lacs) |
| Block | 10.00 | |
| Less: Deferred liability | 1.00 | |
| Current Assets | 5.00 | 10.00 |
| Less: Current Liability | 4.00 | 1.00 |
| Miscellaneous Assets | | 1.00 |
| Tangible Net Worth | | 11.00 |
The position is less favourable than the standard one:
Current Ratio = 1.25:1
Debt.Equity Ratio = 0.5:1
POSITION No.13
Current assets decreased against capital decreased Rs.2 lacs each.
| (Rs. in lacs) |
| Block | 10.00 | |
| Less: Deferred liability | 2.00 | 8.00 |
| Current Assets | 4.00 | |
| Less: Current Liability | 4.00 | nil |
| Miscellaneous Assets | | 1.00 |
| Tangible Net Worth | | 9.00 |
| Capital | 10.00 | 8.00 |
| Less: Paid | 2.00 | 1.00 |
| Reserves | | |
| Tangible Net Worth | | 9.00 |
The above position is not favourable over the standard. T.N.W. decreased consequent to repayment of capital.
(13) and (14) are both less favourable than the position indicated in the standard balance sheet.
Current Ratio = 1:1
Debt:Equity Ratio = 0.7:1
POSITION No.14
Current assets decreased against surplus decreased Rs.1 lac each.
| (Rs. in lacs) |
| Block | 10.00 | |
| Less: Deferred liability | 2.00 | 8.00 |
| Current Assets | 5.00 | |
| Less: Current Liability | 4.00 | 1.00 |
| Miscellaneous Assets | | 1.00 |
| Tangible Net Worth | | 10.00 |
| Capital | 10.00 | |
| Reserves | nil | |
| Tangible Net Worth | | 10.00 |
The above position is not favourable over the standard position. T.N.W. decreased consequent to withdrawal of Reserves.
(13) and (14) are both less favourable than the position indicated in the standard balance sheet.
Current Ratio = 1.25:1
Debt:Equity Ratio = 0.60:1
4. CURRENT LIABILITIES INCREASED
POSITION No.15
Fixed liabilities increased against fixed assets increased Rs.2 lacs.
| (Rs. in lacs) |
| Block | 12.00 | |
| Less: Deferred liability | 4.00 | 8.00 |
| Current Assets | 6.00 | |
| Less: Current Liability | 4.00 | 2.00 |
| Miscellaneous Assets | 1.00 | 1.00 |
| Tangible Net Worth | | 11.00 |
| Capital | | 10.00 |
| Reserves | | 1.00 |
| Tangible Net Worth | | 11.00 |
Not vulnerable
current ratio = 1.5:1
Debf.Equity Ratio = 0.7:1
(15) and (17) are equal and (16) slightly less favourable.
POSITION No.16
Fixed liabilities increased against capital decreased Rs.2 lacs.
| (Rs. in lacs) |
| Block | 10.00 | |
| Less: Deferred liability | 4.00 | 6.00 |
| Current Assets | 6.00 | |
| Less: Current Liability | 4.00 | 2.00 |
| Miscellaneous Assets | 1.00 | 1.00 |
| Tangible Net Worth | | 9.00 |
| Capital | | 10.00 |
| Less:paid | | 2.00 |
| Capital Decreased | | 8.00 |
| Reserves | | 1.00 |
| Tangible Net Worth | | 9.00 |
Not vulnerable
current ratio = 1.5:1
Debf.Equity Ratio = 0.9:1
(15) and (17) are equal and (16) slightly less favourable.
POSITION No.17
Fixed liabilities increased against surplus decreased Rs.1 lac.
| (Rs. in lacs) |
| Block | 10.00 | |
| Less: Deferred liability | 3.00 | 7.00 |
| Current Assets | 6.00 | |
| Less: Current Liability | 4.00 | 2.00 |
| Miscellaneous Assets | 1.00 | 1.00 |
| Tangible Net Worth | | 10.00 |
| Capital | | 10.00 |
| Reserves | | nil |
| Tangible Net Worth | | 10.00 |
Not vulnerable
current ratio = 1.5:1
Debf.Equity Ratio = 0.7:1
(15) and (17) are equal and (16) slightly less favourable.
5. FIXED LIABILITIES DECREASED
POSITION No.18
Fixed liabilities decreased against fixed assets decreased Rs.1 lac.
| (Rs. in lacs) |
| Block | 9.00 | |
| Less: Deferred liability | 1.00 | 8.00 |
| Current Assets | 6.00 | |
| Less: Current Liability | 4.00 | 2.00 |
| Miscellaneous Assets | 1.00 | 1.00 |
| Tangible Net Worth | | 11.00 |
current ratio = 1.5:1
Debf.Equity Ratio = 0.5:1
(19) and (20) are equal but (18) slightly less favourable.
POSITION No.19
Fixed liabilities decreased against capital increased Rs.1 lac.
| (Rs. in lacs) |
| Block | 10.00 | |
| Less: Deferred liability | 1.00 | |
| Current Assets | 6.00 | |
| Less: Current Liability | 4.00 | 9.00 |
| Miscellaneous Assets | 1.00 | |
| Less: paid | | 2.00 |
| Reserves | | 1.00 |
| Tangible Net Worth | | 12.00 |
current ratio = 1.5:1
Debf.Equity Ratio = 0.4:1
(19) and (20) are equal but (18) slightly less favourable.
POSITION No.20
Fixed liabilities decreased against surplus increased.
| (Rs. in lacs) |
| Block | 10.00 | |
| Less: Deferred liability | 1.00 | 9.00 |
| Current Assets | 6.00 | |
| Less: Current Liability | 4.00 | 2.00 |
| Miscellaneous Assets | 1.00 | 1.00 |
| Tangible Net Worth | | 12.00 |
current ratio = 1.5:1
Debf.Equity Ratio = 0.4:1
(19) and (20) are equal but (18) slightly less favourable.
6. FIXED ASSETS INCREASED
POSITION No.21
Fixed assets increased Rs.2 lacs against capital increased.
| (Rs. in lacs) |
| Block | 12.00 | |
| Less: Deferred liability | 2.00 | 10.00 |
| Current Assets | 6.00 | |
| Less: Current Liability | 4.00 | 2.00 |
| Miscellaneous Assets | 1.00 | 1.00 |
| Tangible Net Worth | | 13.00 |
| Capital | | 10.00 |
| Less: paid | | 2.00 |
| Paid up capital | | 12.00 |
| Reserves | | 1.00 |
| Tangible Net Worth | | 13.00 |
Current ratio = 1.5:1
Debf.Equity Ratio = 0.46:1
Both these positions are equal and both are considered good and better than the standard one.
POSITION No.22
Fixed assets increased Rs.2 lacs against surplus increased.
| (Rs. in lacs) |
| Block | 12.00 | |
| Less: Deferred liability | 2.00 | 10.00 |
| Current Assets | 6.00 | |
| Less: Current Liability | 4.00 | 2.00 |
| Miscellaneous Assets | 1.00 | 1.00 |
| Tangible Net Worth | | 13.00 |
| Capital | | 10.00 |
| Reserves | | 3.00 |
| Tangible Net Worth | | 13.00 |
Current ratio = 1.5:1
Debf.Equity Ratio = 0.46:1
Both these positions are equal and both are considered good and better than the standard one.
7. FIXED ASSETS DECREASED
POSITION No.23
Fixed assets decreased Rs.2 lacs against capital decreased.
| (Rs. in lacs) |
| Block | 8.00 | |
| Less: Deferred liability | 2.00 | 6.00 |
| Current Assets | 6.00 | |
| Less: Current Liability | 4.00 | 2.00 |
| Miscellaneous Assets | 1.00 | 1.00 |
| Tangible Net Worth | | 9.00 |
| Capital | | 8.00 |
| Reserves | | 1.00 |
| Tangible Net Worth | | 9.00 |
Current ratio = 1.5:1
Debf.Equity Ratio = 0.7:1
Weaker than (21) and (22)
POSITION No.24
Fixed assets decreased Rs.1 lac against surplus decreased.
| (Rs. in lacs) |
| Block | 9.00 | |
| Less: Deferred liability | 2.00 | 7.00 |
| Current Assets | 6.00 | |
| Less: Current Liability | 4.00 | 2.00 |
| Miscellaneous Assets | 1.00 | 1.00 |
| Tangible Net Worth | | 10.00 |
| Capital | | 10.00 |
Current ratio = 1.5:1
Debf.Equity Ratio = 0.6:1
Weaker than (21) and (22)
The above are twenty three different variations worked out from a simple Balance Sheet. What do we learn from this analysis?
We learn first that the strength of the structural positions of any Balance Sheet is not static, but very much dynamic and moves in strength or weakness according to the nature of each transaction recorded on it. Every transaction is recording its own impact upon the Balance Sheet, and makes its structural strength to either improve or regress. Structural strength is measured in two ways namely :
(a) The relation to the capacity of the enterprise to meet its current liabilities at any point of time and
(b) In relation to the total assets held to meet the outside liabilities.
Greater the ability of any enterprise to meet its current liabilities greater will be its credit strength. Lesser the totality of liabilities in relation to total assets held greater will be the enterprise's credit strength. The enterprise will not be able to remain as an enterprise unless it is able to meet its financial obligations in terms of commitments, and this is assessed by evaluation of its structural position presented by the relationship of assets and liabilities.
Before concluding, we give below an illustration to indicate how the current ratio is influenced by the management's decision to finance the current assets through a long term or short term source.
| A. Ltd. Balance Sheet as at 31.12.22 |
|---|
| (Rs. in lacs) |
| Liabilities | | Assets | |
|---|
| Capital | 950 | Net fixed assets | 1000 |
| Current liabilities | 950 | Current Assets | 900 |
| 1900 | | 1900 |
Current Ratio = 900/950 = 0.94
| Management decision | Impact on current ratio |
|---|
| 1. Raise long term source and acquire current 1200 assets | 1200/950=1.26 |
| 2. Raise long term source and wipe-out current 900 liabilities | 900/650=1.38 |
| 3. Dispose of fixed assets and acquire current 1200 assets | 1200/950=1.26 |
| 4. Dispose of fixed assets and wipe-out current 900 liabilities | 900/650=1.38 |
| 5. Raise short term loan and acquire current 1200 assets | 1200/1250=96 |
| 6. Dispose of current assets and liquidate current 600 liabilities | 600/650=0.92 |
A company improves its efficiency only when it is able to maximise the level of operations with minimum current assets without jeopardising its liquidity.
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