Analysis of the Operation and Financial Condition of the Enterprise

Analysis of the Operation and Financial Condition of the EnterpriseAt the normal level this ratio should not exceed 40%. Creditors usually want tosee lower debt ratios, because it is more certain that they would without any obstructionsreceive the amounts lent. Higher debt ratio means that high interest rate is paid on theloans, and the terms of crediting will be strict or an enterprise may even lose the chance toreceive a loan.Risk plays the main role in assessment of the level of liabilities. Most often thereare two types of risk that the enterprises may face: business risk associated with normal level of activities in the operating conditions; financial risk arising from the method by which the enterprise assets are financed.The underlying principle is as follows: if the business risk is high, neither thefinancial risk should be undertaken.The size of the level of liabilities depends also on the state legislation regardingissuing of loans, the interest rate as well as the peculiarities of an enterprise, the area ofbusiness etc. conditions.The financial independence of an enterprise is also described by a measure calledthe independence ratio which is also called the financial leverage (gearing) which iscalculated by dividing the liabilities of an enterprise by its equity:Financialleverage =(gearing)LiabilitiesEquity capital(4.9.)Ratio shows, what the amount of borrowed capital payable per one lat of equity capitalis. Dynamic increase in this ratio may evidence the ability of the enterprise to expand itsoperations on the account of raising the debt capital. At the same time it may be anindicator of a growing financial dependence on borrowed capital.Experts believe that if the level of this ratio has reached 1, the financial stabilityof an enterprise is under the threat, however, there is no one single solution regarding thecritical limit of this ratio. This ratio depends on the type of business activities and the rateof turnover of current assets. If the turnover of current assets is high, the critical limit ofthis ratio may considerably exceed 1 without seriously affecting the financial autonomy ofan enterprise.Creditors usually select the lower level of this measure. High level of dependencefrom external debt may considerably impair the conditions of an enterprise incircumstances when the rate of sales of goods is decreasing, because the expenses forpayment of interest on loans are believed to be relatively fixed, i.e., the expenses which inother similar conditions would not decrease proportionally with the reduction in the salesvolume of goods.Evaluation of this measure depends on the following positions: the level of the ratio in other industries; what the possibilities are for an enterprise to receive further loans; stability of business performance.74