Ratio Analysis: Understanding Coverage Ratios and Their Significance for Financial Analysis

The video tutorial covers various coverage ratios, including preference dividend and fixed charges coverage ratios. It explains how these ratios measure a company's ability to meet its financial obligations. The preference dividend coverage ratio assesses the company's capacity to pay dividends to preference shareholders, while the fixed charges coverage ratio evaluates the ability to cover fixed debt payments. The tutorial provides formulas, examples, and the significance of these ratios in financial analysis.

What is the primary focus of coverage ratios?

• To measure a company's profitability

• To assess a company's ability to meet its fixed liabilities

• To evaluate a company's market share

• To determine a company's growth potential

What does the preference dividend coverage ratio indicate?

• The number of times a company can pay its taxes

• The number of times a company can pay its preference dividends

• The number of times a company can pay its operating expenses

• The number of times a company can pay its equity dividends

How is the preference dividend coverage ratio calculated?

• Net profit divided by total dividends

• Net operating income divided by preference dividends

• Earnings before interest and tax divided by preference dividends

• Earnings after tax divided by annual preference dividend amount

What is a potential red flag for investors regarding the preference dividend coverage ratio?

• A ratio equal to one

• A consistently low ratio

• A consistently high ratio

• A fluctuating ratio

What does the fixed charges coverage ratio measure?

• A company's ability to pay its variable expenses

• A company's ability to pay its fixed debt obligations

• A company's ability to pay its taxes

• A company's ability to pay its dividends

Which component is added back to EBIT in the fixed charges coverage ratio calculation?

• Interest

• Taxes

• Depreciation

• Principal repayment

Why is the principal repayment divided by (1 - tax rate) in the fixed charges coverage ratio?

• To include interest payments

• To reflect gross of tax payments

• To adjust for inflation

• To account for tax savings

What is considered a safe fixed charges coverage ratio?

• Exactly zero

• Less than one

• Equal to one

• More than one

Which ratio helps determine how many times interest can be paid from EBIT?

• Preference dividend coverage ratio

• Interest coverage ratio

• Debt service coverage ratio

• Fixed charges coverage ratio

What is the significance of a higher coverage ratio?

• Shows a company's strong financial position

• Demonstrates a company's high market share

• Reflects a company's low profitability

• Indicates a company's inability to meet obligations