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A gifts and homewares business sells goods such as candles, bags, cushions, soaps, and jewellery - HSC - SSCE Business Studies - Question 23 - 2022 - Paper 1
Question 23
A gifts and homewares business sells goods such as candles, bags, cushions, soaps, and jewellery. They have provided the following financial information: Operating... show full transcript
Worked Solution & Example Answer:A gifts and homewares business sells goods such as candles, bags, cushions, soaps, and jewellery - HSC - SSCE Business Studies - Question 23 - 2022 - Paper 1
Step 1
Calculate the efficiency (total expenses + total sales) of this business.
Answer
To determine the efficiency of the business, we need to calculate the total expenses and total sales.
- Total expenses = $600,000
- Total sales (operating income) = $1,500,000
Using the formula for efficiency:
ext{Efficiency} = rac{ ext{Total Expenses}}{ ext{Total Sales}}
Substituting the values:
ext{Efficiency} = rac{600,000}{1,500,000} = 0.4
Thus, the efficiency of the business is 40%.
Step 2
Explain how the expense ratio can help this business determine their efficiency.
Answer
The expense ratio is crucial as it reflects how much a business spends in relation to its revenue.
- Efficiency Measurement: A lower expense ratio indicates better efficiency, meaning the business uses its resources effectively to generate income.
- Cost Management: By analyzing the expense ratio, the business can identify areas of overspending. If they are spending 1 earned, reducing this ratio can enhance profitability.
- Strategy Development: Understanding the expense ratio helps in strategic decisions, as it highlights how adjustments in spending can lead to improved financial performance.
Step 3
Why is the level of gearing an important consideration for the lender to this business?
Answer
The level of gearing is vital for lenders because it indicates the proportion of debt versus equity used to finance the business.
- Risk Assessment: A higher gearing ratio means more debt, which can increase financial risk, affecting the business's ability to repay loans during downturns.
- Creditworthiness: Lenders assess the gearing level to determine the financial stability and creditworthiness of the business, impacting decisions on loan amount and interest rates.
- Interest Coverage: Additionally, a reasonable level of gearing suggests that the business can cover interest payments comfortably, making it a safer bet for lenders.
Step 4
Using the financial information provided, explain why the business should use debt finance to acquire the two stores.
Answer
Debt finance can be advantageous for the business's expansion, considering the following points:
- Availability of Capital: The business has the opportunity to borrow $3,000,000 at a low interest of 4%, which provides sufficient funds for expansion.
- Maintain Ownership: Using debt allows the owners to retain full control over the business without diluting equity.
- Leverage Profitability: With an existing net profit of $500,000, the additional revenue from the new stores can cover the interest payments, thus enhancing overall profitability.
- Tax Advantages: Interest on debt is tax-deductible, which can further improve financial efficiency. Hence, pursuing debt finance can facilitate growth without risking ownership.