Dear Robert, I have used the statements you provided me with to come to a decision regarding finance.

Based on the figures and reasons in the below report it is with great pleasure that I approve your business loan. It is in my opinion that Creative Activities has certain areas it needs to look at, these areas may become bigger issues if they are not addressed. But I also feel Creative Activities has adequate cash flows to cover the finance costs. Below I have reported all figures and meanings for ratios and how these ratios influenced my 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 is no huge improvement in these results, it shows that the company is stable and can maintain steady returns. Gross profit margin has gone up from 57.53% to 57.93%. Gross profit is a reflection of the direct return on sales, without taking into account the operating costs of the company. An increasing GP might indicate that Creative Activities has either been able to achieve a higher price point, secure a discount on direct costs involved in producing the product, or a combination of both. This is an encouraging result. Profit margin has moved in a positive direction from 2010 to 2011, this is a good result for Creative Activities. An increase in GP has also influenced the bottom line, which has resulted in a slightly increased Profit Margin. However, while sales have grown by 0.6%, selling, admin and finance expenses have grown by 1.4%. This suggests that there may be some efficiencies to gain in these areas, potentially achieving an even better profit margin in future years. Current ratio for Creative activities has gone down from 4.09 in 2010 to 3.91 times in 2011. This is an unfavourable trend, although, bearing in mind that the arbitrary benchmark is $1.50, having a high current ratio is not always good, as it 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 didnt 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.

Michael Punter

Swinburne ID 9566244

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 collected 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 entitys ability to convert sales revenue into profit and its
ability to generate income from its asset investments.


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

Gross profit margin ratio compares an entitys gross profit to its sales revenue reflecting the proportion of sales revenue that results in gross profit generated per dollar of sales revenue.
 

Profit margin ratio reveals what percentage of sales revenue dollars results in EBIT (earnings before
interest and taxes), it is the comparison of sales revenue and EBIT.


Current ratio is commonly used to asses an entitys liquidity. The current ratio indicates the dollars
of current assets the entity has per dollar of current liabilities.
 

Quick asset ratio measures the dollars of current assets available (excluding inventory) to service each dollar of current liabilities. The quick asset ratio is a more solid test of the companys liquidity because it excludes inventory as inventory often takes the longest to convert to
cash.
 

Debt to equity ratio indicates how many dollars of debt exist per dollar of equity financing.
 

Debt ratio indicates how many dollars of liabilities exist per dollar of assets. 50% or more indicates the entity relies more on debt, 50% or less indicates the entity relies more on equity to finance assets.
 

Times inventory turnover/Times debtors turnover relates to the amount of times per year that inventory/accounts receivable are turned over (converted to cash and re-stocked). The higher the figure the more efficient the entity would appear to be at converting inventory and accounts receivable
to cash. Times debtors:Times inventory:     

 

Michael Punter

Swinburne ID 9566244

Ratio
Return on Assets

2011 000
672 2262 x 100

2010 000
663 2233 x 100

Calculations
assets @ start of period assets @ end of period

2011 000
2233 2291 4524

2010 000
2233 2233 2233

ROA

29.70%

29.69% average assets for year profit divide by AVG assets equals times 100 equals %

4524/2 2262 2233 663/223 3 0.2969 29.69 1865 1865 1865

672/2262 0.297 29.7 1865 1916 3781

Return on equity

665 1890.5

x 100

656 1865

x 100

equity @ start of period equity @ end of period

ROE

35.17%

35.17% average equity for year profit divide by AVG equity equals time 100 equals %

3781/2 1890.5 665/1890. 5 0.3517 35.17 2614 4512 0.5793 57.93 1865 656/186 5 0.3517 35.17 2578 4481 0.5753 57.53

Gross Profit Margin

2614 4512

x100

2578 4481

x100

gross profit divide by sales revenue equals, times 100 equals %

GP

57.93% 672 4512 x 100

57.53% 663 4481 x 100 EBIT sales revenue equals times 100 672 4512 0.1489 14.89 663 4481 0.1479 14.79

Profit Margin

Profit margin

14.89%

14.79%

equals %

Current Ratio

1272 325 3.91 times

1324 323 4.09 times

current assets divide by current liabilities equals

1272 325 3.91

1324 323 4.09

Current ratio

Quick asset ratio

717 319 2.24 times 2.52 times

791 313

current assets minus inventory equals

1272 555 717

1324 533 791

Quick asset ratio

current assets(-inv) divide by current liabilities(-overdraft) equals

717 319 2.24

791 313 2.52

Michael Punter

Swinburne ID 9566244

Debt to equity ratio

Debt-Equity Ratio

375 1916

x 100

368 1865

x100

total liabilities divide by total equity equals times 100

375 1916 0.1957 19.57

368 1865 0.1973 19.73

19.57%

19.73%

equals

Debt ratio

375 2291

x 100

368 2233

x 100

total liabilities divide by total assets equals times 100

375 2291 0.1636 16.36

368 2233 0.1648 16.48

Debt Ratio

16.36%

16.48%

equals

Times inventory turnover

1898 544 3.48 times

x 100

1903 533 3.57 times

x 100

Inv. @ start of Period Inv. @ end of period

533 555 1088

533 533 533

Inv. T/O

1088/2 Average inventory A/R at beginning of period A/R at end of period 544 591 637 1228 533 591 591 591

Time debtors turnover

4512 614 7.34 times

4481 591 7.58 times

Debtors T/O

1228/2 average accounts receivable 614 591

References used :Birt, J., Chalmers, K., Byrne, S., Brooks, A. And Oliver, J. 2010, Accounting-business reporting for decision making, 3rd Edition, John Wiley & Sons, Milton. Boland, G. 2010, Study Guide Accounting-business reporting to decision making, 3rd Edition, John Wiley & Sons, Milton. Learning Materials. 2011, Learning materials Accounting fundamentals ACF110, Learning and teaching services, Lilydale.

Michael Punter

Swinburne ID 9566244