Evaluation of the Application for Lease by Creative Activities Ltd Company - Case Study Example

Evaluation of the Application for Lease/Rental Facility Report Prepare for Creative Activities Pty Ltd Ratio Calculation Year 2007 2008 Return onAsset 29.33 % 29.31 % Return on Owners Equity 34.71 % 34.70 % Gross Profit Margin 57.93 % 57.53 % Net Profit Margin 14.89 % 14.80 % Average Inventory Turnover 106.73 Days 104.34 Days Average Settlement Period for Debtors 73.61 Days 71.45 Days Current Ratio 3.91 Times 4.07 Times Quick (Acid) Ratio 2.21 Times 2.43 Times Gearing Ratio 2.54 % 2.36 % 1. Influence on Bank decision 2. Business ability to service – why yes or no 3. Explain difference between Lease Finance Rental Finance Brief report on Assessment decision From the Financial information provided by Robert, it shows that Creative Activities Ltd is involved in the sales of Sporting Equipments and facilities. RATIO EXPLANATION Return on Asset An asset is defined as a resource of an entity controlled by it as a result of past events and from which future economic benefits are expected to flow to the entity. Return on assets defines as to how the assets of the company are used to generate the returns. A higher asset turnover would suggest and efficient use of resources of the firm and effective management practices. For the two periods 2007 and 2008, comparison of the Return on assets shows a slight change from 29.33% to 29.31%. This slight decrease in the returns on assets can be attributed to the reduced sales as well as addition to the assets of the company. Return on Owners Equity The return on owner’s equity again shows a slight decrease from 34.71% to 35.70% for the two periods. In absence of industry ratios, we may not fully comment on whether the returns generated on owners’ equity are as per industry standards. However, from the calculated ratios, it seems the company is enjoying a good return on its owner’s equity. This is also a good sign considering the fact that the gearing ratio is too small showing the ability of the company to finance its operations through its internally generated funds. Gross Profit Margin The gross profit margin indicates how much company has earned after deducting its direct and indirect costs related with the generating products or services. It is calculated by deducting cost of sales from the sales figures generated by the company. GP Margin reduced from 57.93% to 57.53%. A decrease of .40%.This is mainly due to the increased costs involved in producing equipments and clothing specially. Further it also indicated how well the costs are controlled at the company and its efforts to generate the sales. Though the ratio has slightly dropped however it is still healthy and indicates the cost control measures in place at the company. . Net Profit Margin The net Profit margin shows how much company has earned after paying off all its costs and expenses. It is what is left for the shareholders to distribute among themselves after netting off from sales all the expenses for the year. The net profit margin figures also show a slight decrease for the year 2008 by .09%. This of course reflects the decrease in Net profits before tax for 2008. It was mainly due to an increase in Staff wages expense during the year and a decrease in sales. However despite the slight decrease, it still shows a positive output resulting in a Net profit margin of 14.80% in the latest year. Average Inventory Turnover The average inventory turnover shows how quick inventories are bought, converted into finished goods and finally sold. A higher inventory turnover shows the effectiveness of the management in terms of controlling its production facilities besides suggesting a synergy between the production as well as marketing departments of the organization. It also needs to be understood that a higher inventory turnover would also outline two things. It is either that the goods company produced are readily saleable in the market and carry high demand and secondly goods are of perishable nature In this case, the days in inventor has decrease from 107 days to 104 days showing the fact that company has been able to generate cash from the sales it made more quickly and further it may have streamlined its production facilities to streamline it more with its sales activities to generate rapid sales. Further a higher inventory turnover may also suggest that the company may have started some promotional activities throughout the year especially heavy discounts and price reductions to generate the sales. Given the fact that sales have declined, we may attribute this fact very clearly to the fact that reduction in inventory in days might have been achieved through price reductions. Average Settlement Period for Debtors. The average settlement period for Debtors show how much days the buyers of the company enjoy the purchase on credit. This basically outlines one component of the overall credit extension policy of the company. In this case, it showed favorable as the days decrease from 52 days to 48 days showing more stringent policy being adapted by the company in terms of extending goods on credit. This further corroborates our assessment that the inventory turnover has improved because of the price reductions however on more strict credit terms. Current Ratio The current ratio shows the ability of the company to pay off its immediate liabilities falling within one year and often categorized under current liabilities.i.e. A measure of liquidity of the company. As seen from the figures, the current ratio increase from 3.9 to 4.1. This is an excellent ratio as it shows the strong capability of the company to service its debts and payoff its immediate liabilities. However, a higher current ratio also outlines that the company has engaged its most liquid assets into non-productive use. Quick Acid Ratio If we go by a conservative means of analysis, quick acid ratio indicated the most important measure of the liquidity of the company. It is calculated after deducting non-liquid assets such as prepayments, inventory etc. As discussed above that this is the most conservative form of liquidity. Quick ratio of the company has improved showing much improved performance of the company. Gearing Ratio Gearing outlines the use of debt by the company. The gearing of the company has reduced showing the less reliance of the company on external sources of finances to run its operations. SUMMARY By taking into account all these factors, it seems that Creative Activity Ltd has does considerably well for its operation throughout the two years. In determining the Liquidity of the company, the Current and Quick acid ratios indicates a high % of liquidity exposing that it is able to meet its current obligations by on average 3 times as much. This shows that the Liquidity position of the company is well on industry level. With this we can say that the company is able to repay its debts quickly should the need arise to do so. In terms of profitably, the operations of the company have shown favorable results of sales throughout the two years as compared to the cost of goods bought and sold. Through the Gross Profit margin, we see an average of 57% for the two years indicating that it had made twice as much on income from stocks purchased alone. After all other deductions, the net profit margin still shows a positive figure and although they may have dropped slightly, it still is making profits on an average of 14% from its operations. Also from the Return on Assets ratio it tells us that the assets of the company generates in around 30% of profits to the company. Hence the assets of the company do still function normally thus bringing in future economic benefits to as defined by its nature. Also as seen from the Return on Owners Equity, it has increase indicating a favorable return for shareholders and those having interest in the company. It also shows that the company is steady. Therefore, in regard to the profitability of the company, it is seen to be favorable in this regard We saw that the company is efficient enough to run its operations through its Efficiency ratios. It average turnover rate shows an average of 105 days and average settlement period from debtors of 50 days. This indicates to us that the company takes around 3and 1/2 months to sell its stock and reorder and just below two months to get back its dues from its debtors. Above factors provide enough evidence to suggest that the Creative Activity Ltd is a company which is well managed and generate enough cash flows to pay off its liabilities. Further, the working capital management is excellent and coupled with the excellent liquidity position of the company conclude that Creative Activity Ltd qualifies for loan south of K40, 000 and we have no hesitation in approving the loan on a Finance Lease facility. The difference between the lease and rental Finance Facility and the advantages of Lease from Rental? Lease finance Lease finance is an agreement whereby the lessor conveys to the lessee in return for a payment or series of payments for the right to use an asset for an agreed period of time. Rental finance term Rental is the agreement whereby an individual or a group agrees to pay a certain amount in order to use something of value for certain period of time but will not own the equipment at the end of the rental contract agreement instead the ownership still remains with the person renting out the item. Disadvantage The disadvantage of a rental finance from a lease finance is that for rental finance, once the period for renting expires, the company/individual doesn’t own the equipment accept goes back into another rental agreement if they would still want to rent it, whereas if it was with the Lease Finance, the leaser would own the equipment at the end of the lease period by making a one off payment of the remaining value. Advantage The advantage of Lease from Rental is that the equipment or property will being lease will transfer ownership from the lessee to the lessor if stated in the lease agreement upon expire of the lease period. Also another advantage is that it is cheaper to lease out equipment than it would be if rented and the cost in the long run is far less than that of renting. Read More