Analysis and Interpretation of Balloons N Stuff Pty Ltd - Case Study Example

Analysis and Interpretation Case Study [Student’s Name] [Institution Name] [Tutor’s Name] 12 September 2011 Table of Contents Table of Contents ii Executive Summary iii Introduction 1 Sources of Finance 1 Factors to consider before extending a loan 2 Profitability 2 Liquidity 2 Stability (solvency) 3 Recommendations 3 Conclusion 4 References 5 Appendix 6 Shortcomings of financial statement analysis 6 Calculations of ratio analysis 8 Executive Summary This report makes an analysis and interpretation of Balloons ‘N’ Stuff Pty Ltd case. The report evaluates the profitability, liquidity and stability (solvency) of the Balloons ‘N’ Stuff Pty Ltd business to assess its loan application status. The report is based upon a thorough analysis of the financial reports of the last three years of business operations. In addition, the report will consider the financial situation of the applicant before any loan is made. The report makes recommendations regarding the loan and it is expected that the manager will follow recommendations from this report when extending a loan to the applicants. The report has recommended that Warratah Bank should make the loan requested to Balloons ‘N’ Stuff Pty Ltd. This recommendation has been arrived at after investigating and establishing that Balloons ‘N’ Stuff Pty Ltd is financially sound Analysis and Interpretation Case Study Introduction Data from business financial statements can be used to determine the financial ratios and flow of funds of the business. The funds flow statement will show how the business obtained and used the resources at its disposal during a given time period (Chance, & Brooks, 2009). Therefore, this will help to reveal areas of mismanagement and hence potential danger implying that the business if extended some loan may not be in a position to honour its debt obligation. For the purpose of the loan application, the report is much concerned with the balance sheet and the income statement of Balloons ‘N’ Stuff Pty Ltd. According to “Australian Accounting Standards Board” (2004), the balance sheet states the business assets, liabilities and shareholders equity (net worthy) at a particular date. On the other hand, the income statement reveals the performance of the business during a particular period of time. It indicates the revenue from sales and various costs including interest expense and taxes which the business has incurred during the period. Sources of Finance A growing business requires finances in the course of its business operations. There are several sources of finance that are available to business which are broadly categorized internal and external sources. External sources are usually important especially when the business does not have enough working capital and or its reserves are not adequate to boost the business operations to the next level (Johnston & Clark, 2008). These external sources include the loan facility extended by commercial banks. Factors to consider before extending a loan A loan evaluation officer will take into considerations many factors before granting a loan to the applicant. The loan evaluation officer will normally make a thorough analysis of the financial reports of the business in order to ascertain the profitability, liquidity and stability (solvency) of the business in question. Profitability A profitable business has high chances of meeting its debt obligations as opposed to a business that constantly realize loss out of its operations. The profitability of the business is determined by the profitability ratios of the business. These ratios indicate the ability of the business to make profits or returns from its investment (Davis, et al., 2009). This includes profitability in relationship to sales and profitability in relationship to investment. Since profitability ratios are measures of the ability of the business to make profits or returns from its investment, profitability indicators of 63.95%, 30.20%, 29.83% and 61.15% suggest that Balloons ‘N’ Stuff Pty Ltd is a profitable business. Liquidity A business venture that has a good liquidity position is in a position honour its financial obligations (short term financial obligations) when they become due for payment. The liquidity of the business is shown through the liquidity ratios. These ratios measure the ability of the business to meet the short term financial obligations of the business as and when they fall due (Donald, et al., 2009). As the current ratio is a measure of the ability of the business to meet its short term debts from its current assets a current ratio of 5.039:1 suggests that the business has a good liquidity position and should be able to meet its current liabilities when they fall due. Stability (solvency) A stable business can continue being in business for a long time and is not likely to default in its debt repayment. Stability of the business is indicated by the solvency ratios of the business. These ratios indicate the extent at which the business has borrowed fixed charge sources of finance in order to finance its assets. As stability ratios are measures of the extent at which the business has borrowed fixed charge sources of finance in order to finance its assets, solvency indicators of 0.615:1 and 0.396:1 suggests that Balloons ‘N’ Stuff Pty Ltd does not have a heavy debt burden against its assets. This implies that the claims of the creditors against the assets of the business are maintained at the minimum and therefore Warratah bank can grant the loan of $240,000 without the fear of the business being declared insolvent (Weygandt, et al., 2009). Recommendations It is recommended in this report that Warratah Bank should make the loan requested to Balloons ‘N’ Stuff Pty Ltd. This is because the profitability indicators show that Balloons ‘N’ Stuff Pty Ltd is profitable since it makes positive returns from its investment. In addition, the liquidity indicators show that the business has a good liquidity position and should be able to meet its current liabilities when they fall due. Furthermore, the stability indicators show that Balloons ‘N’ Stuff Pty Ltd does not have a heavy debt burden against its assets. This report recommends that Warratah Bank demand an additional asset from Balloons ‘N’ Stuff Pty Ltd as collateral against the $240,000 loan. This is because the loan that was granted earlier of $160,000 has not been cleared and therefore the property is still committed. This means that the same property cannot be used as collateral for the new loan that is requested. Conclusion The report has analyzed and interpreted a case of Balloons ‘N’ Stuff Pty Ltd to determine whether the business is legible for a loan of $240,000 from Warratah Bank. The report used the profitability, liquidity and stability of the business to establish its loan legibility. These tests, though not a conclusive evidence for granting a loan, they form good basis for making decisions from an informed position. The analysis was done based on financial statements from the last three financial reports. The report has recommended that Warratah Bank should make the loan requested to Balloons ‘N’ Stuff Pty Ltd. References AASB (Australian Accounting Standards Board), 2004. Framework for the Preparation and Presentation of Financial Statements. Melbourne: Australian Accounting Standards Board. Black, G., 2003. Students' Guide to Accounting and Financial Reporting Standards. London: Financial Times Prentice Hall. Chance, D. M. and Brooks, R., 2009. Introduction to Derivatives and Risk Management. New Delhi: Cengage Learning. Davis, D. et al., 2009. Companies and other business structures: commercial law. Oxford: Oxford University Press. Donald, E. et al., 2009. Intermediate Accounting. New Jersey: John Wiley and Sons. Johnston, R. and Clark, G., 2008. Service operations management: improving service industry. Upper Saddle River NJ: Prentice Hall. Weygandt, J. et al., 2009. Managerial Accounting: Tools for Business Decision Making. New Jersey: John Wiley and Sons. Appendix Shortcomings of financial statement analysis Financial statement analysis has several shortcomings which make it not to be conclusive evidence that a certain applicant is viable for a loan facility. Basing decisions purely on the results of financial statement analysis can be misleading as it wholly relies on the data reported on the financial reports of the business – mainly the balance sheet and the income statement. These data are quantitative in nature and therefore cannot report on the qualitative nature of the business concern. Since the data used in financial statement analysis comes from the financial reports it means that any error in the financial reports will be transmitted to the financial ratios. Therefore, by extension it means that the conclusions drawn from this analysis will be invalid and thereby leading to the making of wrong business decisions (Black, 2003). Financial statement analysis uses the most current financial reports of the business to determine the legibility of an applicant for a loan facility. This being the case, it therefore becomes useless for a new business which has just entered into the market or it is prospective. Such a business cannot be evaluated on the basis of its profitability, liquidity or stability since it does not have past financial reports. Therefore, financial statement analysis is usually limited in scope. However, there are other actions which would add depth, insight and additional information which could be taken when seeking to analyze a business entity that may also impact on the decision of whether to grant a loan or not. These include; Legislation: the loan evaluation officer must consider the laws and regulations in force in that country that govern business operations. For instance, if a certain business is illegal, any business transactions entered with that business are null and void from inception. The bank, for example, cannot institute a legal suit against the business in case of default in payment since it is unenforceable. Therefore, the loan officer must be careful to establish the legality of the business. Business structure: the structure of the business should also be considered when granting or taking a loan. This is because businesses are established but not all withstand the test of time. In the event that a business goes under, the lender is at risk of losing his money especially depending on the structure of the business. For a sole trader and some partnerships they have unlimited liability. If their business is declared insolvent, the lender will have a claim up to their personal belongings to have him paid for the loan extended to the business. Sometimes it may happen that even their personal belongings are not adequate to settle the debt and in that case the lender incurs the loss. Cost benefit consideration: before a decision is made to grant or take a loan, the loan evaluation officer and the applicant must suffice themselves that the loan facility will not impose cost on the many for which the benefits are few. The applicant must consider the cost of servicing the loan against the expected revenue out of the investment made from the loan. The loan officer on the other hand must the administrative cost with respect to the loan granted against the interest income. Calculations of ratio analysis Profitability ratios     Liquidity Ratios   Solvency ratios   Read More