Exercises 3.

T or F
1.Historical comparisons of a business in two different time periods can be analyzed with
profitability ratios.
2.The gross profit margin (GPM) is calculated by using the formula:
(Gross profit ÷ Sales revenue) × 100.
3.ROCE stands for Rate of Capital Expenditure.
4.The profit margin is calculated by using the formula:
(Profit ÷ Sales revenue) × 100.
5.Sales turnover is an example of a profitability ratio.
6.Raising the price of products sold in highly competitive markets does not improve the gross
profit margin (GPM) for the business.
7.The return on financial investments can be analyzed by using profitability ratio analysis.
8.Adopting aggressive promotional strategies that persuade more customers to buy a firm's
products can help to improve its gross profit margin (GPM).
9.The current ratio is calculated by using the formula:
Current liabilities ÷ Current assets.
10.A firm’s financial performance compared with its competitors can be analysed using
profitability and liquidity ratios.
11.The current ratio measures a firm’s liquid assets compared to its current (or short-term)
liabilities.
12.Falling raw material prices that result in lower cost of sales (COS) does not improve the gross
profit margin (GPM) of a business.
13.Liquidity ratios calculate how easily a business can pay off its short term debts by using its
current liabilities.
14.The acid test ratio differs from the current ratio as it excludes the value of stocks which cannot
be quickly turned into cash.
15.Return on capital employed (ROCE), gross profit margin (GPM), and profit margin are all
examples of profitability ratios.
16.The profit margin shows how efficiently a business can turn profits into cash.
17.Introducing new products with a higher profit margin would improve the gross profit margin
(GPM) of a business.
18.The higher the current ratio, the more money is tied up in illiquid resources.
19.The ROCE ratio measures the financial performance of a business compared with the amount
of capital invested in the business.
20.The profit margin shows what proportion of profits are being distributed to shareholders.

Multiple Choices
1. If a business has debtors of $35 000, cash of $50 000, stock of $15 000, and current liabilities
of $13 000, what is its current ratio? 
A. 7.23
B. 7.69
C. 6.33
D. 5.5

2. Which efficiency ratio would improve if a business reduced the amount of loan capital it used
and/or improved its net profit before interest and tax?

3. Improving a company’s marketing to raise sales revenue and reducing supply costs by sourcing
cheaper suppliers is a way to directly improve which ratio?

4. If a business invests $100 in capital, and this generates a $20 return before interest and tax,
what is the ratio of return on capital employed?
A. 20%
B. 2%
C. 22%
D. 25%

5. Which of the following is a strategy to improve the acid test (quick) ratio?
A. Investing in fixed assets
B. Increasing debtor days
C. Reducing overdraft
D. Reducing creditor days
6. Which of the following is a strategy to improve the current ratio?
A. Increase payment period with trade payables
B. Increase payment period with trade receivables
C. Increase overdraft
D. Buy additional fixed assets

7. __________ ratios measure a company’s ability to convert its short-term assets into cash and
settle its short-term debt obligations.

8. Which of the following is a strategy to improve the gross profit margin?

A. Lowering expenses
B. Lowering the cost of goods sold
C. Reducing non-current liabilities
D. Reducing the credit period for customers

8. Lamp Ltd has current assets to the value of $100 000 and current liabilities to the value of $50 
000. Which of the following is their current ratio result?  
A. 1.5:1
B. 0.5:1
C.1:1
D. 2:1

9. Which of the following is not a financial ratio?

A. Net profit margin
B. Gross profit margin
C. Return on capital employed
D. Staff turnover ratio
10.Which of the following cannot be analyzed with a profitability ratio?
A. Historical comparisons of a business in two different time periods
B. A firm’s financial performance compared with its competitors
C. The return on financial investments made
D. The amount of cash spent by the business

11.What does ROCE stand for?

A. Revenues Overheads Costs Expenditure
B. Real Operational Capital Employed
C. Return on Capital Employed
D. Rate of Capital Expenditure

12.How is the gross profit margin (GPM) calculated?

A. Gross profit – Expenses
B. (Gross profit ÷ Sales revenue) × 100
C. Sales revenue – Cost of goods sold
D. (Gross profit ÷ Investment) × 100

13. How is the net profit margin (NPM) calculated?

A. (Net profit ÷ Investment) × 100
B. (Net profit ÷ Sales revenue) × 100
C. Sales revenue – Cost of goods sold
D. Gross profit – Expenses

14. Which of the following would not improve the gross profit margin (GPM) of a business that
operates in a highly competitive market?
A. Introducing new products with a higher gross profit margin
B. Adopting aggressive promotional strategies that persuade more customers to buy its products
C. Raising the price of products sold in highly competitive markets
D. Falling raw material prices that result in lower cost of goods sold
15. How is the current ratio calculated?
A. Current assets ÷ Current liabilities
B. Gross profit ÷ Total costs
C. Fixed assets ÷ Current liabilities
D. Current assets ÷ Trade creditors

16. How does the acid test ratio differ from the current ratio?
A. It excludes the value of stocks which cannot be quickly turned into cash
B. It excludes the value of debtors
C. It is concerned with future cash flows rather than historical cash flows
D. It excludes the value of creditors

17. Which of the following performance measures is concerned with a firm’s liquidity?
A. Acid test
B. Gross profit margin
C. Return on capital employed
D. Net profit margin

18. If current assets equal $15.6 million, current liabilities equal $11.2 million and stock equals
$1.8 million, what is the acid test ratio?
A. 1.65:1
B. 0.89:1
C. 1.39:1
D. 1.23:1

19. If current assets equal $15.6 million, current liabilities equal $11.2 million and stock equals
$1.8 million, what is the current ratio?
A. 0.89:1
B. 1.39:1
C. 1.65:1
D. 1.23:1
20. Which of the following statements best describes the net profit margin (NPM)?
A. It shows what proportion of profits are being distributed to shareholders
B. It shows how well a company is controlling its costs, including expenses
C. It show how efficiently a company is turning profits into cash
D. It shows what return is being made on assets employed in the business

21. The current ratios for four companies are shown below. Which company has the most money
tied up in liquid resources?
A. 1:1
B.0.2:1
C. 1.6:1
D. 2.8:1

22. If sales revenue equals $10 million, cost of goods sold equal $6 million and expenses equals
$3 million, what is the gross profit margin?
A. 40%
B. 20%
C. 35%
D. 10%

23. If sales revenue equals $10 million, cost of goods sold equal $6 million and expenses equals
$3 million, what is the net profit margin?
A. 10%
B. 40%
C. 20%
D. 35%
Case Studies
Case Study 1
LaLa’s Kitchen Co. declares an annual gross profit of $3.5 million, sales revenue of $5.5 million,
and expenses of $1.5 million.

(a)  Calculate LaLa’s Kitchen Co.'s gross profit margin (GPM).

(b)  Calculate LaLa’s Kitchen Co.'s profit margin ratio.

Case Study 2
Jasmine Sportswear Co. (JSC) is a large sportswear manufacturing company. In the first three
months of 2020, JSC reported quarterly profits rising by 6% to $212 million and the gross profit
margin ratio of 53.1%.

[2
(a)  Define the term profit.
marks]

[2
(b)  Calculate the value of JSC's profit during the previous three months.
marks]

[4
(c)  Comment on whether JSC's shareholders would be satisfied with the company's GPM.
marks]
Case Study 3
Study the profit and loss account for Camiko Face Masks Ltd., a business based in Wellington,
New Zealand, that produces face masks and related products. Then answer the questions that
follow. All financial figures are in New Zealand dollars (NZD).

Item 2022 2021

Sales revenue 250,000 260,000

Cost of sales (COS) 162,500 169,000

Gross profit 87,500 91,000

Expenses 26,000 26,000

Rent 45,000 45,000

Profit before interest and tax 16,500 20,000

Interest 6,000 6,600

Tax 2,100 2,680

Profit after interest and tax 8,400 10,720

(a)  Define the term gross profit margin (GPM). [2 marks]

(b)  Define the term profit margin. [2 marks]

Calculate the GPM for Camiko Face Masks Ltd. for both 2022 and 2021 and
(c)  [4 marks]
comment on your findings.

Calculate the profit margin ratio for Camiko Face Masks Ltd. for both 2021 and
(d) [4 marks]
2021 and comment on your findings.

(e) Explain why the profit and loss account records profit before interest and tax. [2 marks]

(f) Explain two possible reasons why Camiko Face Masks Ltd.'s GPM and profit [4 marks]
 margin were lower than previously.

Case Study 4.
Muller Books Limited (MBL) is a small business specializing in publishing and distributing
educational books and resources. The privately listed company was founded by Sarah
Muller. MBL has a small office in Dresden, Germany. The company employs 4 full-time staff and
several part-time staff. Sarah has a good working relationship with her staff and the local bank
manager.
MBL has enjoyed several years of expansion in the provision of online education products, such
as interactive e-books and online teacher training courses for a wide range of subjects. However,
these are becoming somewhat dated and several rival companies have recently established an
online presence in the market. The booming economy has also meant that interest rates in
Germany are on an upwards trend.
Five years ago, Sarah was able to secure a patent (legal protection) on a piece of software used
for MBL’s online teacher training. The company has been dependent on this software for
establishing a broad customer base. Sarah has been informed by Lucy Croft-Wang, her
accountant, that MBL’s software developmental expenses have risen dramatically. Lucy presented
the following financial information for MBL as at 31st December 2021, which raised some
working capital and liquidity issues. All figures are expressed in euros (€):

Cost of sales 90,000

Current assets 60,000

Current liabilities 55,000

Expenses 60,000

Non-current assets 750,000

Non-current liabilities 320,000

Retained profit 85,000

Sales revenue 350,000

Shareholders’ funds 350,000

(a) Define the term non-current assets.     [2

 marks]

Construct a profit and loss account for MBL using the financial [4

(b)
information given above. marks]

[2
(c) Calculate the value of the current ratio.
marks]

Using your answer from question (c) above and the information in the
[4
(d) case study, explain why MBL is said to have “some working capital and
marks]
liquidity issues”.

Examine possible financial strategies that Sarah Muller could use to deal [6
(e)
with her company’s working capital and liquidity issues. marks]

Case Study 5.
Ed Supplies (ES) is an educational supplies business in the United Arab Emirates (UAE). Its head
office is located in an expensive area in Dubai. The managing director and head of sales each
receive large annual bonuses and special allowances such as free housing. 
ES orders supplies mainly from relatively expensive suppliers in the United Kingdom (UK). But
ES has been charging a relatively low price for its products, even though the market is not very
competitive. It has 10 employees and has a warehouse to store the products. In 2021, it had sales
revenue of 40 million AED. It also had an annual gross profit of 20 million AED. Its expenses
were 15 million AED.
Questions
1. Calculate the gross profit margin of ES. [2 marks]
2. Explain two strategies that ES could use to improve its gross profit margin. [4 marks]

Case Study 6.
Use the information given in the previous activity about Ed Supplies (ES) to answer the questions
below.
In 2021, ES had sales revenue of 40 million AED. It also had an annual gross profit of 20 million
AED. Its expenses were 15 million AED.
Questions
1. Calculate ES’s profit margin. [2 marks]
2. Explain two strategies that ES could take to improve its profit margin. [4 marks]

Case Study 7.
Examine the financial data for Company A in Table 2 and answer the questions below.

Table 2. Partial statement of profit or loss for Company A (in thousands of $)

2020 2021

Sales revenue 2000 2400

Cost of sales 1200 1480

Gross profit 800 920

Expenses 600 600

Profit before income and tax 200 320

Questions
1. Calculate the GPM and PM in 2020 and 2021.
2. Why did the GPM decrease from 2020 to 2021, but the PM increase?

Case Study 8.
Examine the data from the financial statements of Zazia Perfumes Ltd, a fictional business based
in Tokyo, which produces beauty products and perfumes. Then answer the questions that follow.
All financial figures are in millions of JPY. 
Table 1. Data from the financial statements of Zazia Perfumes Ltd (in thousands of JPY).

2020 2021

Sales revenue 50 65

Cost of sales 10 15

Expenses 25 30

Non-current liabilities 70 70

Equity 50 50

Questions
1. Calculate the GPM for Zazia perfumes Ltd. for both 2020 and 2021 and comment on
your findings. [4 marks]
2. Calculate the PM for Zazia perfumes Ltd. for both 2020 and 2021 and comment on your
findings. [4 marks]
3. Calculate the ROCE for Zazia perfumes Ltd. for both 2020 and 2021. [2 marks]

Case Study 9.
Nike and Adidas are among the world’s leading sports brands, earning billions of dollars in sales
revenue. They are driven by aggressive marketing strategies, involving for example the
endorsement of celebrity sports figures such as Christiano Ronaldo and Lionel Messi.
Does the popularity of the brand necessarily mean it is financially sound? Compare the sales
revenue, profitability and efficiency ratios of Nike and Adidas in Table 2 and then answer the
questions below.

Table 2: Profitability ratios for Nike and Adidas for 2021.

Sources: Nike and Adidas

Nike Adidas

Sales revenue 46.31 billion USD 21.23 million euros

Gross profit margin 44.8% 50.7%

Profit margin 15.5% 15.45%

Questions
1. Define the term gross profit margin (GPM). [2 marks]
2. Define the term return on capital employed (ROCE). [2 marks]
 3. Explain whether Adidas’s shareholders should be satisfied with the company’s GPM. [2
marks]
Case Study 10.
Chowdary Mills in Mumbai, India, is a small, family-owned business that designs and
manufacturers fabrics. The privately held company was founded by Azra Sayyed and her husband
Zaheer Chowdary. Due to the increase in competition, as well as restrictions caused by the
COVID-19 pandemic in India, the financial situation of Chowdary Mills has worsened.  
Azra and Zaheer’s financial accountant Sana presented the financial information shown in Table
3 for Chowdary Mills. All figures are expressed in Indian rupees (INR).

Table 3. Financial data for Chowdary Mills for the period ending 31 December 2021.

Cash 90 000

Debtors 60 000

Stock / Inventory  55 000

Overdrafts  60 000

Tax 30 000

Trade creditors  50 000

Questions
1. Calculate the current ratio for Chowdary mills. [2 marks]
2. Calculate the acid test (quick) ratio for Chowdary mills. [2 marks]
3. Comment on the figures for the current and acid test (quick) ratio. [2 marks]