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Acf110 Assignment 2

1571 words - 7 pages

Dear Robert,

The statements provided have been used to come to a decision regarding finance.  Based on the figures and reasons in the below report it is with great pleasure that your business loan is approved.  It is the opinion of the bank that Creative Activities has certain areas it needs to look at, these areas may become bigger issues if they are not addressed. But it is also felt Creative Activities has adequate cash flows to cover the finance costs.  Below is reported all figures and meanings for ratios and how these ratios influenced the decision.

The company's ROA and ROE have remained constant over the last two years with only a marginal increase of .01% in ROA.  Whilst there ...view middle of the document...

 Remembering though that having a high current ratio is not always good. This may mean that Creative Activities has too much invested in unprofitable assets.

Quick asset ratio has also gone down from 2.52 in 2010 to 2.24 in 2011 which is also an unfavourable trend. The high ratio suggests that Creative activities might have excess current assets that could be invested in more profitable areas.   A downward trend in current ratio and quick asset ratio is not desirable as it shows that the company is now less 'liquid' than in previous years, and cannot as easily convert its assets to cash, should the company need to do so to repay debt.

Debt to equity ratio is good as it went down in 2011 comparative to 2010 from 19.73% to 19.57%, effectively this ratio is saying that Creative Activities assets are financed 19.57% by external debt and 80.43% by owners equity.

Debt ratio shows a downward trend from 16.48% in 2010 to 16.36% in 2011.  This is a good sign as the benchmark for this ratio is 50%. This suggests that Creative activities can absorb more debt.  For example if the loan was to be approved the debt to equity ratio would become 21.65% and the Debt ratio would become 17.80%, both are still well below the benchmark.

Times inventory turnover from 2010 was 3.57 times and it dropped to 3.48 times in 2011, this is an unfavourable trend. In 2010 Creative activities turned over its stock every 102 days whereas in 2011 Creative activities turned over its stock only every 105 days.  If the stock didn’t sell for 105 days Creative Activities would have been running at a negative cash flow state, because the supplier would have been paid, depending on credit terms, potentially within 30 days.  This decrease in inventory turnover is not encouraging and suggests that the company is not improving its cash flow position.  Having surplus stock sitting around is not desirable.

Times debtors turnover also went down in 2011 as opposed to 2010 by 0.24 times.  This is also another unfavourable trend as it shows that in 2010 debts owed to Creative Activities were collected on average every 48 days and in 2011 it was an average of 50 days.  Debtor turnover is very important to the cash flow state of a business, overdue debtors cost the company time and money and this substantial increase in turnover time shows that the company is not recovering much needed cash as quickly as it should.  

Definitions of ratios:

Return on assets (ROA) ratio compares an entity’s ability to convert sales revenue into profit and its ability to generate income from its asset investments.(Birt 2005)

Return on equity (ROE) indicates the annual return that the entity is generating for owners for each dollar of owners’ funds invested.(Birt 2005)

Gross profit margin ratio compares an entity’s gross profit to its sales revenue reflecting the proportion of sales revenue that results in gross profit generated per dollar of sales revenue.(Birt 2005)  

Profit margin...

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