Read the case study below. Northgate Nurseries sells plants, compost and gardening tools. A drought reduced sales of plants, leaving the business with unsol...
Question 1 Report
Read the case study below. Northgate Nurseries sells plants, compost and gardening tools. A drought reduced sales of plants, leaving the business with unsold inventory. The owner is deciding whether to cut prices before the end of the season. Market research suggests customers will buy more if prices fall.
(a) Identify the financial term used for goods held by a business for resale. [1]
(b) Explain one effect that holding too much inventory may have on Northgate Nurseries' cash flow. [2]
(c) What is one possible disadvantage of cutting prices to clear the inventory? [1]
(d) Explain one financial benefit of selling the inventory quickly, even at a lower price. [2]
Answer Details
(a) Goods held by a business for resale are called inventory, also accepted as stock. [1]
(b) Holding excessive inventory means cash has been spent on plants or other goods that have not yet been sold. [1] This cash is tied up, leaving less available to pay suppliers and other short-term costs, so cash flow may worsen. [1]
(c) A disadvantage of cutting prices is a lower gross profit margin, because each item earns less above its cost. Lower sales revenue per item, or customers expecting future discounts, are also valid disadvantages. [1]
(d) Selling the inventory quickly converts stock into cash. [1] This improves liquidity, enabling Northgate Nurseries to pay debts or purchase products that are likely to sell more quickly. [1]
Key distinction: Inventory is an asset, but it cannot pay a bill until it is sold and turned into cash.
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