The following data is from Delta’s common size financial statement:
Earnings after taxes 18%
Current assets 60%
Current liabilities 30%
Total assets $1,400
What is Delta’s total-liabilities-to-equity ratio?
The correct answer was A) 1.5.
Schewser’s explanation: If equity = 40% of assets, total liabilities = 60% of assets, thus 60 / 40 = 1.5.
I thought its total debt divided by total equity i.e. 30% / 40% = .75, which isn’t provided in the answer selections
Why is 60 in the numerator as total debt?
This confused me too, when I was doing level 1. The thing here to notice is “total assets” and “equity”.
Asset = Liability + Equity (or A = L + E ), the asset here refers to Total Asset therefore:
1,400 = Liability + 1,400 * 0.40
1,400 = Liability + 560
Liability = 840
The current liabilities is not the same liability in the A = L + E, it’s only a portion of the L.
Therefore, total liabilities to equity = 840 / 560
Hey @mission, in the balance sheet, total assets = equity + total liabilities = 100%. Given that they are asking for total liabilities to equity ratio, you need to find total liabilities, and that’s 60% (i.e. 100% less equity). Total debt (or current liabilities) alone does not represent TOTAL liabilities as you are missing out on long term liabilities in your calculation.
To break down the first equation above:
1) total assets = current assets + long term fixed assets = 100%
2) equity + total liabilities = equity + current liabilities + long term liabilities = 100%
So if you take current liabilities (30%) only, that does not take into account long term liabilities, which is what the question is asking for.
Hope this helps!
@mission maybe you can see it in this other way:
Assets=Liabilities+Equity … in a common size financial statement, liabilities and equity are expressed as a % of total assets … Equity is 0,4*1400=560 … which means Liabilities=1400-560=840…
Total assets=1400=liabilities+equity (560+840)… so 840/560=1,5.
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