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Creative Activities Pty Ltd Ratios

Banks Assessment The Bank received an application from Mr. Robert Craft requesting a $40,000 financial facility for Creative Activities Pty. Ltd (Creative) to buy office equipment for the expansion of the business. The Bank performed the following assessment: Profitability Analysis Return on Assets Ratio measures the profitability of an entity by comparing its profit with its available assets. Creative shows a 2011 ROA of 29.71% and a 2010 ROA of 29.69%. For each dollar invested in assets the entity obtained 29.71 cents of profit. Remained constant. The Bank considers the entity has a good return over its assets. Increasing debt and investing on the entitys expansion, would also help the business grow and consequently increase the ROE. Return on Equity Ratio indicates how much profit the business generated with the investments of the owners. Creatives ROE for 2011 was 35.18% and for 2010 35.17%. It remained constant and the owner had a return of 35.18 cents of profit for each invested dollar. This ROE indicates that the owner is obtaining a good return over the invested Equities and will likely continue investing in the business. It had a positive effect on the Banks decision. Gross Profit Margin Ratio indicates the gross profit an entity generates for each dollar of sales revenue, and is related to the pricing policy as the gross profit is obtained as sales less cost of sales. Creatives gross profit margin ratio for 2011 was 57.93% and for 2010 57.53%. This increase reveals that, in 2011, for every dollar obtained from sales, around 42 cents were spent in cost of sales, and generated a gross profit of 57.93 cents. This is an excellent gross profit ratio and positive for the Banks decision. Profit Margin Ratio indicates the relation between sales revenue and profit. A high profit margin is desirable because it reveals how many dollars of earnings (before interest and tax) were generated per dollar obtained from sales. Creatives profit margin was of 14.89% in 2011 and 14,80% in 2010. For each dollar of sales revenue it generated 14,89 cents of earnings before interest and tax during each period. This profitability ratio increased slightly and had a positive effect on the Banks decision.

Efficiency Analysis Times Inventory Turnover Ratio reflects how many times per year the inventory is turned over (sold in its totality) and is obtained dividing the cost of sales by inventory. Creative turned over its inventory 3.49 times in 2011 and 3.57 times in 2010, which shows a slight decrease. While not a problem yet, this decrease might be a negative sign as A low turnover implies poor sales and, therefore, excess inventory. A high ratio implies either strong

sales or ineffective 26/04/2011).




Times Debtor Turnover Ratio indicates how many times per year the trade debtors are turned over (how many times per year all the money from trade in accounts receivable is collected). Creative turned over its trade debtors 7.35 times in 2011 and 7.58 times in 2010. This decrease could indicate that the entity might be allowing longer credit terms to clients in order to increase sales. Debtor plus Inventory turnover ratios compose the entitys activity or operating cycle, (time it takes the entity to buy inventory, sell it and collect the dollars from its sales), different from cash cycle that starts when the entity pays for the inventory. A short activity cycle is desired for a better efficiency and liquidity. Turnover ratios did not affect the Banks decision in either way because for a fair assessment these ratios should be compared to industry averages. Liquidity Analysis Current Ratio indicates how many times the current liabilities can be paid with the current assets (how many dollars of current assets the entity has per dollar of current liabilities). In 2011 Creative had 3.91 dollars of current assets per dollar of current liabilities. In 2010 represented the 4.10%. Although decreased, indicates current liabilities can be repaid more than three times during the period. This is a high liquidity ratio, with a positive effect on the Banks decision. Quick Asset Ratio reflects the ability of the business to face its current liabilities and is calculated as current assets excluding inventory (it takes longer to convert into cash than the other current assets) divided by current liabilities. The ratio for 2011 was 2.21 times and for 2010 2.45 times which means the entity had 2.21 dollars of current assets available per dollar of current liabilities. The decrease of this ratio is not good but as the ratio value for 2011 still widely exceeds the benchmark of 1,5 times (Birt et al, p.327), the Bank considered it positive for its decision. Debt to Equity Ratio is a capital structure ratio that shows the relation between external financing (liabilities) and internal funds (equity). Indicates how many dollars of external financing (debt) were obtained per dollar invested by the owner. With a debt to equity ratio of 19.57% in 2011 and 19.73% in 2010 it is reflected that Creative financed its investments in assets more with equity (>80%) than with debt (<20%), which reflects a low Balance Sheet leverage. Positive for the Banks decision, the entity is able to commit to a higher percentage of debt. Debt Ratio indicates the proportion of debt the entity has in relation to its assets. Creative had 16.37% of debt in 2011 and 16.48% in 2010. Only 16.48% of its assets were financed by debt. The ratio kept constant (slight decrease). It is a Positive value, the Bank considers that the entity has the capacity to commit to more debt (which could also benefit the financial leverage of the entity).

Cash Position The entity suffered an important decrease of 60% in available cash in 2011. This could be due to different reasons (purchase of equipment, payment of retained earnings, increase in debtors item probably as consequence of the activity cycle increase, other expenses paid in cash, etc.). Considering the business had a profit of 665k and a liquid cash of 80k in 2011, $40,000 incremental debt seems to be a prudent amount, and the Bank considers Creative has wide repayment ability to face the financial facility obligations. A cash flow analysis would complement the Banks assessment. Banks Decision The Bank considers that Creative Activities Pty Ltd is in good financial health and is pleased to inform that the requested $40,000 financial facility has been granted. The bank will set the repayment terms according to its policies and the entitys repayment capacity.

Birt, J, Chalmers, K , Byrne, S, Brooks, A, Oliver, J , 2010, Accounting- Business Reporting for Decision Making, 3rd edition, John Wiley & Sons Australia, Milton Investopedia Web Page, Dictionary, Inventory Turnover, accessed 26/04/2011,,