Homework SourseJBJ Antiques JBJ reported the following comparative income f
JBJ Antiques (JBJ) reported the following comparative income figures in 2006.
Other income
Your boss, the president of Henry Bank, is concerned about JBJs borrowing capacity. A representative of JBJ feels that there should be no problem, since net profits are the same with slightly higher sales.
Required: Compute times interest earned and comment on the bank\'s position.
| (in thousands) | 2006 | 2005 |
| Net Sales | 701 | 646 |
| Other income | 10 | 8 |
| 711 | 654 | |
| Cost and Expenses: | ||
| Cost of goods sold | 472 | 408 |
| Selling and general expenses | 176 | 156 |
| Interest | 28 | 22 |
| 676 | 586 | |
| Income before income tax and extraordinary item | 35 | 68 |
| Income taxes | (15) | (30) |
| Income before extraordinary items | 20 | 38 |
| Extraoridnary items- Loss on fire | 18 | |
| Net Income | 20 | 20 |
Solution
Solution :Time interest ratio = EBIT ÷ Interest expense
Time interest ratio (2005) = $68 ÷ $22 = 3.09
Time interest ratio (2006) = $35 / $28 =1.25
Time interest ratio used to measure the paying ability of business to its debts. If Time interest ratio is less than 1 that means business is not in a position to meet it\'s interest obligation. In other words, higher the ratio, higher the ability to meet debt obligations
In the given case, the Time interest ratio has substantialy decreased from 3.09 to 1.25 which shows the decreasing ability of the JBJ to pay it\'s debts. However, a representative of JBJ feels that there should be no problem, since net profits are the same with slightly higher sales.
His view is not correct since, net profit is not relevent to the Time interest ratio.
