A gifts and homewares business sells goods such as candles, bags, cushions, soaps and jewellery - HSC - SSCE Business Studies - Question 23 - 2022 - Paper 1

The expense ratio indicates how effectively a business is utilizing its resources. For instance, if the gifts and homewares business spends $0.40 in expenses for each dollar in sales, it signifies that a lower expense ratio correlates with higher efficiency.

In this case, a lower expense ratio would suggest that the business is managing its operating costs well, thereby enhancing profitability. By tracking this metric, the business can identify areas for cost reduction, leading to improved overall efficiency.

Gearing is critical because it reflects the proportion of debt financing in relation to equity. For lenders, a lower gearing level typically indicates less risk, as the business is less reliant on borrowed capital to fund operations. If a business has high gearing, it may struggle to meet its debt obligations, impacting its financial stability.

Lenders will assess the level of gearing to ensure the business can manage its debt and possibly determine access to additional financing.

The business should consider using debt finance for expansion due to several advantages. Given that the current owner's equity stands at $1,800,000 and total liabilities are$2,000,000, leveraging debt can amplify growth without diluting ownership.

Furthermore, with an operating income of $1,500,000, the business demonstrates substantial revenue, indicating it can service debt repayments. By borrowing$3,000,000 at a relatively low interest rate of 4%, the business can invest in growth while maintaining its cash flow and minimizing equity dilution, ultimately boosting profitability in the long term.