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Solvency Ratio Analysis

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8 views4 pages

Solvency Ratio Analysis

Uploaded by

syedagulezahrarizvi
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Solvency Ratio Analysis

Introduction

Solvency ratios are key financial metrics used to assess a company’s ability to meet its long-
term obligations. They provide insights into a firm’s financial stability and long-term
sustainability by evaluating the proportion of debt in its capital structure relative to assets,
equity, and earnings. A strong solvency position ensures that a company can continue its
operations without facing financial distress or insolvency.

SOLVENCYRATIOS
YEAR 2020 2021 2022 2023
NONCURRENTLIABILITIES 8,538,360 5,709,285 9,369,173 9,930,357
CURRENTLIABILITIES 46,758,606 63,902,250 77,766,101 76,681,319
TOTALLIABILITIES 55,296,966 69,611,535 87,135,274 86,611,676
NONCURRENTASSETS 26,286,510 29,771,273 33,284,260 36,366,356
CURRENTASSETS 28,359,297 55,161,740 68,448,109 69,982,310
TOTALASSETS 54,645,807 84,933,013 101,732,369 106,348,666
DEBTRATIO 1.01 0.8 0.9 0.81
TOTALLIABILITIES 54,645,808 84,933,014 101,732,370 106,348,667
COMMONSTOCKEQUITY 651,159 15,321,478 14,597,095 19,736,990
DEBTTOEQUITYRATIO 0.84 0.06 0.07 0.05
EBIT -4,375,241 6,584,879 3,274,450 9,026,827
INTEREST 1,514,063 834,770 1,358,252 2,499,147
INTERESTCOVERAGERATIO -2.89 7.89 2.41 3.61
EBIT -4,375,241 6,584,879 3,274,450 9,026,827
FixedCharges 9,282,255 6,392,157 10,318,778 11,276,720
InterestExpense 1,514,063 834,770 1,358,252 2,499,147
FixedPaymentCoverageRatio(FPCR) 0.45 1.80 1.16 1.47

Who Uses Solvency Ratios and Why?

1. Investors & Shareholders:


o Assess long-term financial health and risk before making investment
decisions.
o Determine whether the company can generate enough earnings to sustain debt
repayment.
2. Creditors & Lenders:
o Banks and financial institutions use solvency ratios to evaluate loan eligibility.
o Ensure the company has the capacity to repay borrowed funds.
3. Management & Executives:
o Monitor financial risk and manage capital structure effectively.
o Make informed strategic decisions regarding debt financing and expansion
plans.
4. Regulatory Authorities:
o Ensure compliance with financial regulations and capital adequacy
requirements.
o Assess risk levels in industries with high leverage, such as energy and oil
companies.

Importance in Shell Pakistan’s Financial Report


Shell Pakistan Limited, a major player in the petroleum industry, operates in a capital-
intensive sector where solvency is crucial. Due to the volatile nature of oil prices and
economic fluctuations, Shell must maintain a strong solvency position to withstand
downturns, manage debt, and finance future growth.

Why Solvency Analysis is Important for Shell Pakistan?

 The company relies on both debt and equity financing for its operations and
expansions.
 High leverage could lead to financial risk if cash flows are insufficient to cover
obligations.
 Investors and stakeholders need assurance that Shell Pakistan has the capacity to
sustain its operations in the long run

Debt-to-Assets Ratio
Formula:

Debt-to-Assets Ratio=Total Assets/Total Debt

Interpretation:

 Shows the proportion of assets financed by debt.


 A lower ratio indicates financial stability, while a higher ratio suggests potential
liquidity concerns.

Impacting Factors:

 Asset Base Growth – Expansion through asset purchases affects this ratio.
 Debt Management – Increased borrowing increases the ratio.
 Depreciation & Asset Valuation – Changes in asset values impact the ratio over
time.

HISTORICAL ANALYSIS

2020: Debt Ratio = 1.01 (Critical Situation)

 A debt ratio of 1.01 indicates that Shell Pakistan had more liabilities than assets.
 This means Shell was in a highly leveraged and financially unstable position.
 The oil and gas industry suffered in 2020 due to COVID-19 lockdowns, reduced
fuel demand, and supply chain disruptions.
 Liquidity constraints and economic downturns might have forced the company to
rely more on debt.
2021: Debt Ratio = 0.80 (Improvement)

 A significant drop in the debt ratio


to 0.80 suggests that Shell reduced
its dependency on liabilities or
increased asset accumulation.
 The rise in current assets (from
PKR 28B to PKR 55B) suggests
improved cash flow and inventory
management.
 Economic recovery post-COVID-
19 and rising oil prices globally
might have helped improve financial
health.

2022: Debt Ratio = 0.90 (Increase in


Leverage)

 The ratio increased again to 0.90, indicating higher reliance on debt.


 This could be due to increased operational and capital expenditures or strategic
investments.
 The industry faced volatile oil prices and inflationary pressures, which might have
led to higher working capital needs.

2023: Debt Ratio = 0.81 (Slight Recovery)

 The ratio declined slightly to 0.81, indicating a more balanced capital structure.
 Asset growth was notable, with total assets reaching PKR 106B, showing
expansion.
 The company might have controlled borrowing or increased profitability, stabilizing
its financial position.

Absolute and Industry Context Analysis

 Oil and Gas Industry in Pakistan:


o Generally operates with high leverage due to capital-intensive operations.
o Companies need large investments in infrastructure, refineries, and supply
chains.
o Competitors like Attock Petroleum and PSO also have high debt ratios but
may have different financing strategies.
 Impact of COVID-19 (2020–2021):
o 2020: Industry faced major disruptions, leading to financial distress.
o 2021: Global economic recovery improved financial conditions.
 Debt Sustainability:
o The ideal debt ratio varies by industry, but a ratio above 0.80 suggests high
financial risk.
o While Shell's debt ratio decreased post-2020, it remained high, meaning
financial risk persists.
Conclusion & Recommendations

 2020 was the worst year due to extreme financial distress.


 2021 saw improvement, possibly due to debt repayments or better revenue.
 2022 showed a rise in leverage, which may indicate expansion or higher borrowing.
 2023 improved slightly, but debt reliance remains a concern.

Recommendations:

 Shell should reduce financial risk by controlling debt levels and enhancing cash
flow.
 Diversification and cost optimization can help lower reliance on liabilities.
 Monitoring macroeconomic conditions (oil prices, inflation, currency depreciation)
is essential to manage financial stability.

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