Trouble Plc is considering selling some of its accounts receivable to reduce its bank overdraft as they are concerned about the level of interest being charged. The cheapest way of doing this, and the method Troublr Plc has chosen, is to sell the receivables ‘with recourse’. How will Patio Lines times-interest- earned and current ratio appear following the restructuring compared to their current 3 times interest earned and 0.7 current ratio?

anyone get this, its a good one. I know recourse is bad from the seller’s viewpoint, since they have to cover any receivables not received ( i.e, they pay the buyer no matter what) that is all I know. I think the CR would change and be lower? You sell A/R and get cash, but get LESS cash then if you would just wait for receivables to come in (since all factoring is done at a discount) not sure…ANYONE?

i agree… you sell your receivables (already an asset) for a little less therefor less current assets to cover interest and less assets for current ratio (might have to be briefed on the interest coverage ratio tho)

the analyst should income this back into assets and debt for ratio purposes however I am not too sure if the debt is current or not. I think times interest earned ratio will descrease because of the addition to interest expense and CR will increase due to the addition back to assets. Not to sure though…

*include not income

sorry guys after reading the Q again I think I misread the question, I think it’s time to pack it in for tonight

times-interest-earned: decrease. Both EBIT and interest expense increase by the same amount. With original number of 3, denominator effect dominates, so result is decrease. Current ratio: increase Adjustment requires to add current liability and add current asset (A/R), numerator effect dominates, current ratio increase.

hopetobeat Wrote: ------------------------------------------------------- > times-interest-earned: decrease. > Both EBIT and interest expense increase by the > same amount. With original number of 3, > denominator effect dominates, so result is > decrease. > > Current ratio: increase > Adjustment requires to add current liability and > add current asset (A/R), numerator effect > dominates, current ratio increase. well done! You rock!

strangedays Wrote: ------------------------------------------------------- > hopetobeat Wrote: > -------------------------------------------------- > ----- > > times-interest-earned: decrease. > > Both EBIT and interest expense increase by the > > same amount. With original number of 3, > > denominator effect dominates, so result is > > decrease. > > > > Current ratio: increase > > Adjustment requires to add current liability > and > > add current asset (A/R), numerator effect > > dominates, current ratio increase. > > > well done! You rock! where is the EXTRA interest expense coming from? from the RECOURSE?

ya, for analysis you must add it back to asset AND debt

recievable is usually sold at discount, treated as interest expense.

most analyst treat a sale of receivables with recourse as a collateralized borrowing

getterdone Wrote: ------------------------------------------------------- > ya, for analysis you must add it back to asset AND > debt this is why I got lost. Doesn’t cash + interest > interest added to CL, so current ratio goes up???

anyone, are we SURE the CR goes up, not down???

the amount added to asset is that amount that you sold at the discount. if you sold $10 of recievables with recourse for 8, then 8 would be added to asset and the 2$ would be charged to debt as interest. This would increase CR This is how I look at it, not too sure if its right though, if someone could verify would be helpful

getterdone Wrote: ------------------------------------------------------- > the amount added to asset is that amount that you > sold at the discount. > > if you sold $10 of recievables with recourse for > 8, then 8 would be added to asset and the 2$ > would be charged to debt as interest. > > This would increase CR > > This is how I look at it, not too sure if its > right though, if someone could verify would be > helpful Guys I dont have the solution for this, but I aggree with getterdone

Nope. $8 to debt and asset. $2 is increased interest and EBIT.

ah I see now, thanks hope!@

I don’t seem to follow the explanation for the second part above? why does the EBIT/ Int expense ratio decrease?

Jamms Wrote: ------------------------------------------------------- > I don’t seem to follow the explanation for the > second part above? why does the EBIT/ Int expense > ratio decrease? agree, I am having a hard time with this one. can someone explain clearly, in $ terms what happens to both ratios, using the $10 of AR sold for 8 and recourse. Is that even how you phrase this? thanks