The following financial information relates to two businesses in the same industry for the year ended 31 December 2025. Item Business A ($) Business B ($) R...

(a) Ratio calculations

(i) Gross profit margin

Gross profit margin = Gross profit / Revenue x 100

Business A: 80 000 / 200 000 x 100 = 40% [1]
Business B: 96 000 / 320 000 x 100 = 30% [1]

(ii) Net profit margin

Net profit margin = Net profit / Revenue x 100

Business A: 30 000 / 200 000 x 100 = 15% [1]
Business B: 38 400 / 320 000 x 100 = 12% [1]

(iii) Current ratio

Current ratio = Current assets / Current liabilities

Business A: 45 000 / 25 000 = 1.8 : 1 [1]
Business B: 72 000 / 48 000 = 1.5 : 1 [1]

(iv) Acid test ratio (quick ratio)

Acid test ratio = (Current assets - Inventory) / Current liabilities

Business A: (45 000 - 15 000) / 25 000 = 30 000 / 25 000 = 1.2 : 1 [1]
Business B: (72 000 - 24 000) / 48 000 = 48 000 / 48 000 = 1.0 : 1 [1]

(v) Return on capital employed (ROCE)

ROCE = Net profit / Capital employed x 100

Business A: 30 000 / 150 000 x 100 = 20% [1]
Business B: 38 400 / 240 000 x 100 = 16% [1]

(b) Profitability comparison

Business A has a higher gross profit margin (40% vs 30%), indicating it retains a greater proportion of each dollar of revenue after deducting the cost of goods sold. This could be due to better buying terms, higher selling prices, or a different product mix. [1]

Business A also has a higher net profit margin (15% vs 12%), showing that after all expenses are deducted, A converts more of its revenue into profit. This suggests better control of operating expenses relative to sales. [1]

Business A has a higher ROCE (20% vs 16%), meaning each dollar of capital invested generates a better return. For owners and investors, this is a key measure of how efficiently the business uses its resources. [1]

However, Business B generates higher absolute profit ($38 400 vs $30 000) and much higher revenue ($320 000 vs $200 000), suggesting a larger scale of operation that may offer growth potential. [1]

(c) Liquidity comparison

Business A has a higher current ratio (1.8:1 vs 1.5:1), indicating a stronger ability to meet its short-term obligations using its current assets. Both ratios are within the generally acceptable range, but A has a more comfortable margin. [1]

Business A also has a higher acid test ratio (1.2:1 vs 1.0:1). The acid test strips out inventory (which may not be quickly converted to cash), giving a more conservative view of liquidity. [1]

Business B's acid test ratio of exactly 1.0:1 means it can just barely cover its current liabilities from its liquid assets (cash and trade receivables), leaving no safety margin. [1]

Overall, Business A is in a stronger liquidity position. Business B may face difficulty if a large creditor demands immediate payment or if some receivables prove uncollectible. [1]

(d) Two limitations of using ratios for inter-business comparison

1. The businesses may use different accounting policies (for example, different depreciation methods or inventory valuation methods), which affect the figures and make direct comparison unreliable. [1]
2. Ratios are based on historical data and may not reflect the current trading conditions or future prospects of either business. A snapshot of one year may not represent the long-term trend. [1]