Profitability & Liquidity Ratio Analysis (DP IB Business Management: SL): Exam Questions

Mountain Adventure Gear is a small business that sells outdoor equipment such as hiking boots, tents, and climbing gear. The company’s sales have grown steadily due to increased interest in outdoor activities. However, its financial statements reveal that while revenue has increased, its gross profit margin has decreased.

To address this, the company’s management is exploring ways to reduce direct costs, such as negotiating with suppliers or finding cheaper raw materials. They are also reviewing their pricing strategy, considering whether raising prices for premium products could help offset the rising cost of goods sold.

Additionally, Mountain Adventure Gear is evaluating its return on capital employed (ROCE) to determine whether its recent investment in a new warehouse is generating sufficient returns.

Mountain Adventure Gear is a small business that sells outdoor equipment such as hiking boots, tents, and climbing gear. The company’s sales have grown steadily due to increased interest in outdoor activities. However, its financial statements reveal that while revenue has increased, its gross profit margin has decreased.

To address this, the company’s management is exploring ways to reduce direct costs, such as negotiating with suppliers or finding cheaper raw materials. They are also reviewing their pricing strategy, considering whether raising prices for premium products could help offset the rising cost of goods sold.

Additionally, Mountain Adventure Gear is evaluating its return on capital employed (ROCE) to determine whether its recent investment in a new warehouse is generating sufficient returns.

Artisan Furniture is a business that produces handmade wooden furniture, including tables, chairs, and cabinets. While the company has maintained steady sales, it has faced challenges with rising material costs and delivery delays.

The company’s recent Statement of Profit or Loss shows that its gross profit margin has declined, although operating expenses have remained constant. Artisan Furniture is considering ways to improve profitability, such as sourcing materials from local suppliers to reduce costs and renegotiating trade credit terms to improve liquidity.

Additionally, management is using liquidity ratios to assess the company’s ability to meet short-term obligations while maintaining adequate cash flow for daily operations.

Artisan Furniture is a business that produces handmade wooden furniture, including tables, chairs, and cabinets. While the company has maintained steady sales, it has faced challenges with rising material costs and delivery delays.

The company’s recent Statement of Profit or Loss shows that its gross profit margin has declined, although operating expenses have remained constant. Artisan Furniture is considering ways to improve profitability, such as sourcing materials from local suppliers to reduce costs and renegotiating trade credit terms to improve liquidity.

Additionally, management is using liquidity ratios to assess the company’s ability to meet short-term obligations while maintaining adequate cash flow for daily operations.

Zenith Publishing specialises in producing e-books and printed novels for a niche audience. The company has seen a steady increase in revenue over the past year but is facing profitability challenges due to rising overhead costs, such as higher rents and utility expenses for its office and warehouse.

Zenith’s management is considering reducing operating expenses by transitioning more operations online, such as offering digital-only publishing services. They are also reviewing their gross profit margin and return on capital employed (ROCE) to determine if their current investment in print publishing remains financially viable.

Additionally, Zenith’s recent liquidity ratios have revealed a slight decrease in the acid test ratio, prompting concerns about its ability to meet short-term financial obligations.

Zenith Publishing specialises in producing e-books and printed novels for a niche audience. The company has seen a steady increase in revenue over the past year but is facing profitability challenges due to rising overhead costs, such as higher rents and utility expenses for its office and warehouse.

Zenith’s management is considering reducing operating expenses by transitioning more operations online, such as offering digital-only publishing services. They are also reviewing their gross profit margin and return on capital employed (ROCE) to determine if their current investment in print publishing remains financially viable.

Additionally, Zenith’s recent liquidity ratios have revealed a slight decrease in the acid test ratio, prompting concerns about its ability to meet short-term financial obligations.

UrbanPrint Ltd provides customised printing services for small businesses and events. The company prides itself on offering competitive prices while maintaining quality. In 2024, UrbanPrint earned $342,560 in revenue and incurred $158,240 in cost of goods sold. Operating expenses, including rent and marketing, totalled $78,450.

ActivePulse Ltd produces and sells fitness trackers designed to help customers monitor their health. The company has been focusing on reducing production costs and streamlining operations. For 2024, management set a goal of achieving a profit margin greater than 15% to attract new investors. They are reviewing financial data to assess if they have met this target.

ClearFlow Ltd specialises in manufacturing eco-friendly water filtration systems, catering to environmentally conscious households and businesses. The company has invested heavily in new technology and marketing campaigns to boost profitability. Management has set an ambitious target to achieve a return on capital employed (RoCE) greater than 12%.

EcoGrow Ltd sells indoor gardening kits and accessories, targeting urban customers who want to grow their own herbs and vegetables. After a strong year of sales, the company is reviewing its liquidity position to ensure it can meet its short-term obligations in 2024. Management is particularly concerned about maintaining a healthy current ratio to support future investments in product development.

TechSpark Ltd designs and sells high-end smart home devices. The company is reviewing its liquidity and is particularly focused on its acid test ratio, as its management wants to ensure that short-term liabilities can be covered without relying on inventory. With a push to increase its market share, TechSpark has a significant amount of stock in hand.

SoleMate operates a successful chain of shoe shops specialising in affordable yet fashionable footwear for men, women and children. The company’s stores are currently located in suburban shopping centres known for their convenience, ample parking and appeal to family-orientated, budget-conscious shoppers. This location strategy has helped SoleMate grow steadily over the past decade, building strong brand loyalty among families

Recently, however, SoleMate has faced declining sales in its suburban locations due to increased competition from online retailers offering wider selections and discounts. To address this, the company’s management is considering expanding into urban high streets. This strategic move aims to attract younger, trend-conscious consumers, improve brand visibility and rejuvenate the SoleMate brand

The shift to urban areas comes with significant challenges. Urban high street rents are 50% higher than those in suburban shopping centres, adding financial pressure. Additionally, SoleMate must invest an estimated $65,000 per store to redesign interiors, improve aesthetics and tailor its product range to suit urban tastes. Despite these costs, management believes urban stores could bring long-term growth by positioning SoleMate as a more modern and dynamic brand

To evaluate this decision, the company conducted market research, including competitor analysis and customer surveys. The findings showed that 65% of urban shoppers prioritise affordability, but brand image and style are also critical factors. A competitor analysis revealed that rival urban shoe stores charge an average of $50–$70 per pair of shoes, a price point SoleMate could compete with by carefully managing production and overhead costs

Management forecasts that each new urban store could generate a monthly revenue of $25,000, with operating costs projected at $18,000. If successful, this strategy could offset the decline in suburban sales and enable SoleMate to reach a new, profitable market segment. However, there is a risk that the urban move may alienate SoleMate’s core family-orientated customers if brand messaging becomes too focused on younger demographics

The decision to expand will require careful consideration of the financial, operational and strategic implications to ensure the expansion aligns with SoleMate’s long-term goals

Table 1: Financial comparison – Suburban vs urban locations

Table 2: Competitor analysis – Urban shoe retailers

Graph 1: Customer priorities for urban shoe shopping

The following graph illustrates urban customers’ priorities when shopping for shoes, based on SoleMate’s market research.

Established as a sole trader business in 2009, Gourmet Bakehouse is a producer and retailer of premium handmade baked goods. The business is well known for its high-quality gluten-free bread, pastries and custom cakes. It has a small production facility and sells its products directly through a retail store and local cafés. The Bakehouse is popular for its excellent quality and has many loyal customers. As the business grew, its owners, Maria and James, decided to form a private limited company

Recently, the company signed a contract to supply baked goods to a large retail chain. This new contract is a big opportunity for growth but also brings challenges. The company’s current production facilities are working at full capacity, so Maria and James have identified the need to invest in more equipment to meet demand. They must decide whether to lease equipment or buy custom-built machines. Leasing costs less initially but is more expensive over time. Custom-built machines cost a lot upfront but are more efficient and cheaper in the long run

Maria and James are also thinking about how to grow their business. Maria wants to create an online ordering and delivery service. She likes this idea because it would allow the business to grow quickly and reach more customers without needing a physical store. James prefers opening a new outlet in a nearby city. He believes doing so would help build a long-term presence, make the brand more visible and allow customers to experience the Bakehouse in person. Both options have advantages, but Maria and James need to choose the best one for their business goals and finances

Each choice comes with risks and benefits. The decision about equipment and expansion will have a big impact on the Bakehouse’s future. Maria and James must think carefully about how their choices will affect the company’s reputation for quality and its long-term success

Table 1: Financial data for equipment options

Table 2: Financial data for expansion options

Graph 1: Projected revenue growth over five years