Which Shareholders Equity can Fulfil a Company’s Obligations to Creditors in the Event of Liquidation

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A high gearing ratio represents a high proportion of debt to equity

 

SKU: REPO202481 (2)

According to Accounting Tools (n.d.) ‘the gearing ratio is the proportion of a company’s debt to its equity. A high gearing ratio represents a high proportion of debt to equity, and a low gearing ratio represents a low proportion of debt to equity. The ratio indicates the financial risk to which a business is subjected. This ratio is similar to the debt to equity ratio…’ According to Investing Answers (26 June 2012) ‘the debt to equity ratio is the measure of the relationship between the capital contributed by creditors and the capital contributed by shareholders.  It also shows the extent to which shareholders equity can fulfil a company’s obligations to creditors in the event of liquidation’.  For example, total debt/total equity.

I choose to look at Equipment and Supplies Ltd (E & S Ltd) financial statements which is ideal for this discussion.  E & S Ltd is a company owned by just one person.  The company is engage in shipping, office space rentals, equipment rentals and purchases of heavy-duty equipment and many other commodities. The company consist of six workers but deals with high-value commodities; therefore it is a requirement by law to report its financial transactions through statements.

In the early years of establishing Equipment & Supplies Ltd (E & S) the company’s major source of finance was the Bank of Montserrat.  The company borrowed substantial amount of funds to finance its business operations about 30 years ago.  Within the first 10 years of its operations the company has manage to clear all its long-term debts.  From then to now the company only has short term debts and that is their suppliers and these are paid on a monthly basis.

Short-term debts $ 920,000.00

Long-term debts   $xxxxxxxxx

E & S Ltd is a company that is financially stable and the owner is the only shareholder and investor in the business.  All of the company’s profits and equity is retained by the company to be reinvested into the company and is recorded under shareholder equity on the balance sheet.  According to Kennon (n.d.) ‘shareholder Equity is the net worth of a company. It represents the stockholders’ claim to a business’ assets after all creditors and debts have been paid. Shareholder equity is also referred to as Owner’s or Stockholders’ Equity. It can be calculated by taking the total assets and subtracting the total liabilities’.

Formula to calculate Shareholders Equity

Shareholders Equity = Total Assets – Total Liabilities

OR

Shareholders Equity = Share Capital + Retained Earnings – Treasury Shares

 

E & S has managed to stay in the profit margins for the past 15 years and has become one of the main companies that are likely to attract investors.  However, the owner prefers to remain as the sole investor and shareholder of the company.

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