Interpretation of Financial Position and Health
Loan Covenants
The Bank requires the following covenants to be fulfilled in order to obtain the load you requested:
Enclosed in the report are all the bank’s requirements regarding the financial statements including the balance sheet, income statement, statement of retained earnings and a statement of cash flows generated using the direct method. This covenant has been met.
The working capital ratio of Lululime Ltd. is greater than that which was required by the bank (2.524584980 > 1.75). This ratio is a measure of how well you can pay off your current liabilities with current assets. The larger this ratio the better position you are in to pay off your current debts and the less risk you pose to the bank. Since your working capital ratio was larger than required, that means that this covenant has been met as well.
The debt to equity ratio measures your company’s risk of defaulting (failing to pay back the loan). The bank requires a debt to equity ratio of less than 0.75 in order to grant Lululime Ltd. the loan. Since 0.6375293480 is less than 0.75, you have met this covenant.
The gross profit ratio is a good indicator of the profit a business makes on its costs of goods sold. The higher the figure is, the more profit your company is making relative to the cost of goods sold.The ratio is to be greater than 0.25 to facilitate the loan. Lululime Ltd.’s gross profit ratio is larger than required (0.289130434 > 0.25) and therefore that covenant has been met.
Finally, the bank necessitates that cash flow from operations be positive in addition to being greater than all disbursements to shareholders including dividends, share repurchases, or other forms of compensation. Total operational cash flows for this month have in fact been negative, totaling $2,500. Furthermore, cash flow from operations was much smaller than the disbursements to the shareholders of the company (-$2,500.00 in operational cash flows compared to $564.00 in dividends paid out). Hence, because these last two covenants have not been met, the bank will not grant Lululime Ltd. the loan.
Return on Assets
Knowing the return on assets ratio is useful to you because it will help you judge whether borrowing cash is worthwhile. Right now the ratio lies at about 2.975%; this means that unless you can borrow cash at an interest rate lower than 2.975%, it is probably a good idea to avoid loaning money. This is so as the return your company will generate will most likely not be worth incurring the cost of interest on the loan. If you can borrow cash for less than this figure, borrowing the most cash possible would be a good idea as you will be netting profit in the amount of your return on assets minus the cost of interest.
Increasing Gross Profit Ratio
Increasing the gross profit ratio of your company involves increasing revenue and decreasing CoGS (cost of goods sold). One way to increase revenue and thus the gross profit ratio is to increase the markup on your product(s) in order to improve revenue from sales. This would only work assuming that people would pay the higher price for the same quantity of sales. Another way you could increase the ratio is to find a homogenous supplier of fabric who can offer you supplies for a lower cost. This would reduce the CoGS and hence increase the gross profit ratio.
Generation of Income but not Cash
The reason why net income is positive yet you ended up with less cash than you began with is explained by two reasons. The first is that in order to cover the costs of the company’s purchases over the month your cash was needed to finance them. This caused a large reduction in cash. Looking on your statements it is easy to see that even though your net income was positive, not everything used to calculate the net income involved cash. Non-cash items such as amortization on capital assets and credit in accounts payable are included in net income yet make no changes to the physical cash amount. Therefore net income (in your case) tends to be, at best, only a loose measure of cash on hand.