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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 calculate the efficiency of the business, we first need to determine the total expenses and total sales.
- Total Expenses: This includes expenses of $600,000.
- Total Sales (Operating Income): This is reported as $1,500,000.
Now we can sum these:
Total Expenses + Total Sales = 1,500,000 = $2,100,000.
Next, we compute the efficiency ratio:
Efficient Ratio = ( \frac{Total\ Expenses}{Total\ Sales} \times 100 )
( \frac{600,000}{1,500,000} \times 100 = 40% ) and expressed as a decimal, it is 0.4.
Step 2
Explain how the expense ratio can help this business determine their efficiency.
Answer
The expense ratio is a key indicator of how well a business utilizes its resources. It measures the amount spent on expenses relative to total sales.
- A lower expense ratio indicates higher efficiency, as it suggests that the business is spending less on operational costs per dollar of sales.
- By analyzing the expense ratio, management can identify areas where costs can be reduced without sacrificing quality or service.
- Monitoring this ratio over time allows the business to track its operational effectiveness and profitability. In this case, the gifts and homeware business currently spends 1 of revenue. This shows that by managing indirect costs strategically, they can enhance their overall efficiency and profitability.
Step 3
Why is the level of gearing an important consideration for the lender to this business?
Answer
Gearing refers to the ratio of a company’s debt to its equity. It is important for lenders to consider this level for several reasons:
- Financial Stability: A high gearing ratio may indicate that a business is heavily reliant on debt for its operations, which poses a greater risk in periods of financial instability.
- Risk Assessment: Lenders assess the level of gearing to determine the risk of lending. If the gearing ratio is too high, it suggests the business might struggle to meet its financial obligations.
- Loan Repayment Capacity: Understanding the level of gearing helps lenders evaluate whether the business can comfortably manage additional debt without jeopardizing its ability to repay existing loans.
Step 4
Using the financial information provided, explain why the business should use debt finance to acquire the two stores.
Answer
There are several reasons why the business should consider using debt finance for acquiring the two new stores:
- Leverage: Debt financing enables the business to leverage its existing capital. With total liabilities of 1,800,000, the business has room to take on additional debt while remaining stable.
- Tax Benefits: Interest payments on debt are often tax-deductible, providing a financial advantage compared to equity financing, where dividends are not tax-deductible.
- Preservation of Ownership: Using debt allows the current owners to retain full control over the business without diluting ownership stakes, which could occur through equity financing.
- Projected Returns: If the new stores are expected to generate a higher return on investment than the cost of the debt (interest payments), it is a financially sound decision. Given the operational revenue of $1,500,000, this suggests that the investment could yield positive cash flows, which would support repayment.