Background
The COVID-19 pandemic put a considerable strain on public finances, more so on government debt. Consequently, there is a negative effect on the fiscal sustainability of nations. Furthermore, individual businesses were affected by the stringent measures such as lockdown and travel bans. For most people, the only way to reestablish their enterprises was through borrowing bank loans. The selected topic for this post is the impact of debts on returns. The research article chosen was written by Colline (2022) with the title: The mediating effect of debt equity ratio on the effect of current ratio, return on equity and total asset turnover on price to book value.
Summary of Colline 2022 Article
The objective of the study was first to examine the consequence of liquidity, activity ratio, and profitability on capital structure and firm value. In addition, the researchers endeavored to find out the mediating role of capital structure. The study was informed by the drastic changes in stock market index following the COVID-19 pandemic (Colline, 2022). The first hypothesis guiding the study was that the current ratio has a positive impact on the price book value. The rationale was that firms have an increased ability to handle short-term liabilities when they have greater current ratio. The other hypothesis was that the return in equity ratio and total asset turnover has a positive effect on the price book value. In addition, the researchers assumed that the return on equity ratio and current ratio has a negative impact on the debt-equity ratio. Their last prediction was that the debt-equity ratio has a mediating effect on the current ratio on price-to-book value.
The independent variables for the study include return on equity (ROE), current ratio (CR), and total asset turnover. The price-to-book (PBV) is the dependent variable while the debt-equity ratio (DER) mediates the effect. Data was collected from the Indonesia stock exchange to get the interim financial reports of companies for the financial year 2020 to 2021. The researchers used Reviews 8 to carry out multiple regression analysis to analyze the relationship. Findings from the study show that return on equity, current ratio, and debt-equity ratio have a significant effect on PBV but the total asset turnover does not have any remarkable impact. From the findings, it is apparent that debt-equity ratio has no mediating effect on the current ratio and ROE or rice book value.
Personal Reactions and Reflections
The research is useful for analyzing the impact of financial crisis and the stock exchange price on finances of the individual companies. Noteworthy, the United States federal debt grew by 100% and the government opted for a zero lower bond economy (Bi et al., 2022). I learnt from the research that companies with high current ratios have greater liquidity and are therefore at minimal risk which enhances the firm value. Investors have more confidence on such companies with higher ROE as it shows the probability for a higher profitability. The implication is that investing in R & D firms which have a low exposure to government debt and pay less expected returns is a good financial decision. Higher ROE implies leads to more retained earnings because of the high profit that the company receives over time. In addition, the retained earnings can be utilized by the firm as a source of funds to minimize debts causing low DER.
From the study, I think a proper financial planning is important when planning to get a loan during times of financial crisis. It is important to understand that the assets that the company has may not be as useful as the real activities. Therefore, the focus should be capitalizing on strategies that increase ROE while minimizing the debt to ensure that the firm does not become bankrupt. It is better to reabsorb all the profit for reinvestment and improving on profitable activities while avoiding debt.
References
Bi, H., Shen, W., & Yang, S. S. (2022) Fiscal implications of interest rate normalization in the United States.Canadian Journal of Economics, 55(2), 865-903. Web.
Colline, F. (2022). The mediating effect of debt equity ratio on the effect of current ratio, return on equity and total asset turnover on price to book value. Journal of Finance and Banking, 26(1), 75-90. Web.