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Analysis of accounts
Revision answers
1 i) Internal: workers would find this useful to see how profitable the business
is and give them an indication of their job security and the chances of them
gaining pay increases.
ii) External: shareholders would want to compare this year’s dividends with last
year’s; assess how profitable the business is and its likely future prospects.
iii) External: the bank would want to check on the risks of the business not
being able to repay its loans (see liquidity ratios).
2 One figure, if not compared with another one, gives no indication of relative size
or improvement/worsening. Ratios allow for much more effective comparisons.
3
Formula Ratio
Net profit Return on capital employed
× 100
Capital employed
Liquid assets (cash + debtors but not inventories) Acid test ratio
Current liabilities
4 This means that for every $1 of capital invested in the business, the business is
making 20 cents profit after tax (net profit) as a return on it.
5 A result of 0.75 means that only 75 per cent of any current (short-term) liabilities
could be paid at the current time from existing current assets.
6
2013 2012 Analysis/Comment
Gross profit margin 13.3% 15% This means the business is making a smaller gross
profit on each item sold – perhaps the cost of sales
has risen or prices of the finished goods have been
reduced.
Management should find out which of these two
things has occurred.
Net profit margin 5.8% 9% This is a bigger fall than in gross profit margin – this
means that the firm’s expenses or overheads have
increased rapidly during 2013.
Management needs to try to reduce expenses without
damaging business efficiency.
Return on capital 8.75% 12.86% This means the business is making substantially
employed less net profit on each $1 of capital employed. The
business is less profitable in 2013 than it was in 2012.
Management needs to take decisions to increase net
profit next year.
Cambridge IGCSE Business Studies 4th edition Teacher’s CD © Hodder & Stoughton Ltd 2013 1
25 Analysis of accounts
Answers to activities
Activity 25.1
a) i) 22.8%
ii) 37.5%
iii) 18.3%
b) Yes: the results for all three ratios are higher in 2013 than in 2012; the business
is making a higher profit on each item sold and is able to make a higher return
on each $1 invested.
Activity 25.2
a) Current ratio = 1.42; acid test ratio = 1
b) The liquidity of the business has fallen using both ratios. Current assets
have fallen in value since 2012 and current liabilities have risen in value. The
management should be worried if this is part of a longer-term trend as falling
liquidity ratios suggest that the business might have problems in paying its
short-term debts.
Activity 25.3
a) No, they should not be pleased, overall. Although GPM has increased both NPM
and RoCE have fallen suggesting that the overhead expenses of the business
have risen during the year. The most significant change has been to NPM which
has fallen from 16 per cent to 12 per cent in one year.
b) By comparing these results with those of other hotels, the management can
assess whether all hotels are experiencing similar trends. If, for example, other
hotels have increased both GPM and NPM then the management of Gloria
Hotels would be advised to look very carefully at the expenses of their business
to see if these could be reduced without damaging the efficiency of the
business.
Cambridge IGCSE Business Studies 4th edition Teacher’s CD © Hodder & Stoughton Ltd 2013 2
25 Analysis of accounts
c) Banks and creditors should be worried about the declining liquidity, especially the
large reduction in the acid test ratio from 1.0 to 0.6. This could suggest that the
business will have problems paying its short-term debts from cash and debtors
(accounts payable) especially if the decline in acid test ratio is a long-term trend.
d) Increase profitability: the managers could increase prices of hotel bedrooms to
try to increase both GPM and NPM but will guests go to other hotels instead?
They could try to increase added value by rebranding the hotel as an upmarket
hotel offering superior service or food but will the costs of the business rise
more than any additional revenue? (Other answers possible.)
Overall student recommendation needed.
e) Sell off assets no longer needed for cash, such as part of hotel garden BUT
will this be sold for a good price and could the garden be useful in future,
for example, for adding value to the hotel’s services? Pay off short-term debts
(current liabilities) by taking out a long-term loan BUT this will increase the
long-term interest payments of the business.
Other answers possible.
Overall student recommendation needed.
Cambridge IGCSE Business Studies 4th edition Teacher’s CD © Hodder & Stoughton Ltd 2013 3
25 Analysis of accounts
d) i) Shareholders would want to see how much sales are falling and how this
is likely to impact on the profits of the business (and future dividends).
[1K; 1App; 1An]
ii) Suppliers/creditors would want to check the liquidity of the business to see
if, despite falling liquidity ratios, Hi Fashion are still able to pay their debts.
[1K; 1App; 1An]
2013 2012
Current ratio (CA/CL) 1.47 2
Cambridge IGCSE Business Studies 4th edition Teacher’s CD © Hodder & Stoughton Ltd 2013 4