IB DP Business Management: Profitability, liquidity and efficiency ratios (HL only) – Practice Questions

These are original questions written for Marlbridge, for revision and practice on this content. They are not reproduced past-paper questions, and they do not replicate the exam’s exact structure, question count or mark tariffs – the IB holds copyright in its own papers. Use these alongside the official past papers available through your school or the IB store.

These questions practise sections 3.5 (Profitability and liquidity ratio analysis, SL/HL) and 3.6 (Efficiency ratio analysis, HL only) of the IB Business management guide, first assessment 2024. Questions 4 to 6 and question 9 are HL only. Money is in dollars and every business is invented.

Questions

1. Define the term “capital employed” and state the formula for return on capital employed (ROCE). [2]

2. Jorvik Fabrics has sales revenue of 640,000, cost of sales of 400,000 and other expenses of 156,800. Its non-current liabilities are 170,000 and its equity is 350,000. It holds surplus cash.

(a) Work out the gross profit margin for Jorvik. [2] (b) Calculate the profit margin (use profit before interest and tax). [2] (c) Calculate ROCE. [2] (d) Explain one way, other than raising profit, to improve Jorvik’s ROCE. [2]

3. Ledbury Print Works has stock of 46,000, debtors of 31,000 and cash of 3,000. It owes creditors 38,000 and has a bank overdraft of 12,000.

(a) Calculate Ledbury’s current ratio. [2] (b) Using the same figures, find the acid test (quick) ratio. [2] (c) Explain why the two ratios differ and what the acid test ratio suggests about Ledbury. [2]

4. (HL only) Distinguish between insolvency and bankruptcy. [3]

5. (HL only) Winnowby Garden Centre had cost of sales of 540,000 and sales revenue of 810,000 for the year. Opening stock was 48,000 and closing stock was 60,000. Debtors were 66,600 and creditors were 74,000.

(a) Calculate stock turnover in times. [3] (b) Calculate stock turnover in days. [2] (c) Calculate debtor days. [2] (d) Calculate creditor days. [2] (e) Comment on what the debtor days and creditor days suggest about Winnowby’s cash position. [3]

6. (HL only) Zindrel Components has non-current liabilities of 240,000 and equity of 360,000.

(a) Calculate the gearing ratio. [2] (b) Zindrel takes a new long-term loan of 150,000 to buy machinery. Assuming equity is unchanged, calculate the new gearing ratio. [2] (c) Explain one risk and one benefit for Zindrel of operating with the higher gearing ratio. [4]

7. Pidcock Dairy had sales revenue of 900,000 in both of the last two years. Its cost of sales was 612,000 in the first year and 657,000 in the second.

(a) Calculate the gross profit margin for each year. [3] (b) Suggest two possible reasons for the change. [2] (c) Recommend one strategy to restore the first year’s gross profit margin and justify your choice. [3]

8. Ledbury Print Works (from question 3) has current assets of 80,000 and current liabilities of 50,000. Its owner considers two separate options. Option A replaces the 12,000 overdraft with a five-year loan. Option B is a clearance sale of 20,000 of stock at cost price for cash.

(a) Find the acid test ratio if option A is chosen. [2] (b) Find the acid test ratio if option B is chosen. [2] (c) Recommend which option Ledbury should choose, justifying your answer. [4]

9. (HL only) Tolmark Foods has sales revenue of 1,200,000, cost of sales of 730,000 and profit before interest and tax of 120,000. Debtors are 240,000 and creditors are 60,000. Its overdraft of 190,000 is part of current liabilities of 250,000. Non-current liabilities are 300,000 and equity is 200,000.

(a) Calculate debtor days and creditor days. [4] (b) Explain why Tolmark could be insolvent even though it makes a profit. [3] (c) Evaluate two strategies to improve Tolmark’s cash position and justify which is better. [5]

10. Business P is a boutique jeweler with a gross profit margin of 55% and a profit margin of 6%. Business Q sells printer cartridges online with a gross profit margin of 30% and a profit margin of 12%. Analyse what these figures suggest about the two businesses. [4]

Answers

1. Capital employed is non-current liabilities plus equity [1]. ROCE = (profit before interest and tax ÷ capital employed) × 100 [1]. [2] Examiner insight: A definition that names both components, and a formula that names the profit figure in full, leave less room for doubt.

2. (a) Gross profit = 640,000 − 400,000 = 240,000 [1]; margin = 240,000 ÷ 640,000 × 100 = 37.5% [1] (b) Profit before interest and tax = 240,000 − 156,800 = 83,200 [1]; profit margin = 83,200 ÷ 640,000 × 100 = 13.0% [1] (c) Capital employed = 170,000 + 350,000 = 520,000 [1]; ROCE = 83,200 ÷ 520,000 × 100 = 16.0% [1] (d) Reduce capital employed, for example by repaying 70,000 of long-term loan from surplus cash [1]; capital employed falls to 450,000 and ROCE rises to 83,200 ÷ 450,000 × 100 = 18.5% [1]. [8] Examiner insight: Showing each profit figure before reusing it makes your method easy to follow; in (d), recalculate the ratio.

3. (a) Current assets = 46,000 + 31,000 + 3,000 = 80,000 and current liabilities = 38,000 + 12,000 = 50,000 [1]; current ratio = 80,000 ÷ 50,000 = 1.6 [1] (b) Acid test = (80,000 − 46,000) ÷ 50,000 [1] = 34,000 ÷ 50,000 = 0.68 [1] (c) The acid test excludes stock, the slowest current asset to turn into cash [1]. At 0.68, quick assets cover only about two thirds of current liabilities, so Ledbury relies on selling stock or on creditors’ patience [1]. [6] Examiner insight: Interpreting the number for this business tends to do better than only saying stock is excluded.

4. Insolvency is being unable to pay debts as they fall due [1]. Bankruptcy is a legal status or process dealing with unpaid debts [1]. Insolvency is a financial position; bankruptcy is a formal outcome that may follow but is not automatic [1]. [3] Examiner insight: Because the command is distinguish, set the two terms side by side and state how they differ. Keep the legal point general.

5. (a) Average stock = (48,000 + 60,000) ÷ 2 = 54,000 [1]; stock turnover = 540,000 ÷ 54,000 [1] = 10.0 times [1] (b) 54,000 ÷ 540,000 × 365 [1] = 36.5 days [1] (c) 66,600 ÷ 810,000 × 365 [1] = 30.0 days [1] (d) 74,000 ÷ 540,000 × 365 [1] = 50.0 days [1] (e) Winnowby collects in about 30 days but pays suppliers in about 50 [1]. The 20-day gap means supplier credit helps to fund customer credit [1]. A risk is that stretching payments further could strain supplier relationships [1]. [12] Examiner insight: Cost of sales for (a), (b) and (d) but sales revenue for (c) is a common trap; compare the two day figures in (e).

6. (a) Capital employed = 240,000 + 360,000 = 600,000 [1]; gearing = 240,000 ÷ 600,000 × 100 = 40.0% [1] (b) Non-current liabilities = 390,000 and capital employed = 750,000 [1]; gearing = 390,000 ÷ 750,000 × 100 = 52.0% [1] (c) Risk: more of the long-term funds are borrowed, so interest and repayments must be met even if sales fall [2]. Benefit: if the machinery earns more than the loan interest, the extra profit goes to the owners without issuing shares, so ownership is not diluted [2]. [8] Examiner insight: One-word answers such as “risky” gain little; link each point to repayments, profit or ownership.

7. (a) Year one: (900,000 − 612,000) ÷ 900,000 × 100 = 32.0% [1]. Year two: gross profit = 900,000 − 657,000 = 243,000 [1]; margin = 243,000 ÷ 900,000 × 100 = 27.0% [1] (b) Cost of sales rose by 45,000 with no rise in revenue because, for example, supplier costs increased [1]. Prices were not raised to match, perhaps to keep customers [1]. (c) Renegotiate supplier prices [1]. Restoring 32.0% needs cost of sales back to 612,000, a cut of 45,000 or about 6.8% of the year-two figure [1]. A cheaper supplier may reduce quality or reliability [1]. [8] Examiner insight: Quoting a case figure, such as the 45,000 gap, makes a recommendation more convincing.

8. (a) Current liabilities fall to 38,000 and current assets stay at 80,000 [1]; acid test = (80,000 − 46,000) ÷ 38,000 = 0.89 [1] (b) Stock falls to 26,000 and cash rises to 23,000, so current assets stay at 80,000 [1]; acid test = (80,000 − 26,000) ÷ 50,000 = 1.08 [1] (c) Option B gives the higher acid test ratio, 1.08 against 0.89 [1], and adds no new borrowing or interest [1]. However, B needs stock to sell at cost and leaves less to sell later, while A raises non-current liabilities [1]. On the figures, choose B, because it fixes the weak ratio without extra debt [1]. [8] Examiner insight: A clear choice, the calculated figures and one counter-argument give a recommendation its shape.

9. (a) Debtor days = 240,000 ÷ 1,200,000 × 365 [1] = 73.0 days [1]. Creditor days = 60,000 ÷ 730,000 × 365 [1] = 30.0 days [1] (b) Tolmark is profitable: profit before interest and tax is 120,000, a 10.0% profit margin [1]. It pays suppliers after about 30 days but customers take about 73 days, a 43-day gap [1]. A 190,000 overdraft funds the gap, so if the bank withdrew it Tolmark could not pay debts as they fall due: insolvency [1]. (c) Strategy one: cut debtor days to 55 through early payment discounts or credit control. Debtors fall to about 180,800, releasing about 59,000 [1]. Discounts cut revenue and strict terms may lose customers [1]. Strategy two: negotiate longer creditor days [1], which keeps cash longer but may strain supplier relationships. Judgement: strategy one is better because it tackles the larger gap and releases a measurable amount, provided key customers accept it [2]. [12] Examiner insight: Weighing each strategy and then reaching a judgement with case numbers tends to do better than two separate descriptions.

10. Business P keeps 55 cents per dollar of revenue after cost of sales, against Q’s 30 cents [1]. The gap between gross and profit margin is 49 percentage points for P and 18 for Q, which suggests P has much higher overheads, such as shop rent and staff [1]. Q keeps more profit before interest and tax per dollar of revenue, 12% against 6%, despite the lower gross margin [1]. The margins do not show capital used, so ROCE or earlier-year figures are needed to judge which is better [1]. [4] Examiner insight: “Analyse” asks you to break the figures down; working out the margin gap shows more than naming the larger number.

Where marks are usually lost

• Using a profit figure after interest when the formula needs profit before interest and tax.
• Leaving non-current liabilities out of capital employed.
• Dropping the 365, mixing up cost of sales and sales revenue, or using closing stock instead of average stock.
• Quoting a ratio with no unit, or not saying that the acid test removes stock.
• Calling a figure good or bad with no comparison, or recommending a strategy with no cost, risk or case number.
• Treating insolvency and bankruptcy as the same.

Next steps

• Revise with the revision notes.
• Re-read the study guide.
• Use the Business Management hub and printable checklist.
• Try all the free 10-minute diagnostics.
• Practise the wider unit with the Unit 3 practice set.
• Book a free trial class: trial.

Frequently asked questions

Which profit figure do you use for profit margin and ROCE in IB Business Management? The guide’s formulae use profit before interest and tax for both profit margin and ROCE. Using a profit figure after interest is a common way to lose marks.

What are common mistakes on ratio analysis questions? Students often leave non-current liabilities out of capital employed, drop the 365 in days ratios, mix up cost of sales and sales revenue, use closing stock instead of average stock, and quote a ratio with no unit. Calling a figure good or bad with no comparison also loses marks.

Which ratios are HL only in IB Business Management? The efficiency ratios in section 3.6, which are stock turnover, debtor days, creditor days and the gearing ratio, are HL only, along with insolvency versus bankruptcy. The profitability and liquidity ratios in section 3.5 are studied at SL and HL.

How should you recommend a strategy to improve a ratio? Choose a strategy that affects the ratio in the question, link it to the case, and state its cost or risk. A strategy with no trade-off, or one that improves a different ratio, earns less credit.

Official syllabus

International Baccalaureate Organization, Business management guide, first assessment 2024: sections 3.5 and 3.6, the formulae for ratio analysis and the glossary of command terms.