IB Diploma Programme (DP) - SL & HL · Business management

3.5 Profitability and liquidity ratio analysis: Practice Questions

2 multiple-choice questions marked as you go, and 4 written questions with worked solutions. All on 3.5 Profitability and liquidity ratio analysis.

6 questions25 marksFree, no account

Question 1

1 mark

The acid test ratio is often considered a better measure of a firm's immediate liquidity than the current ratio because it excludes which of the following?

Question 2

1 mark

If a company decides to pay off a long-term bank loan early using its existing cash reserves, what will be the immediate impact on its current ratio?

Question 3

5 marks

A company has current assets of $ \$50,000 $, current liabilities of $ \$25,000 $, and inventory valued at $ \$10,000 $. Calculate the acid test ratio and explain the impact on this ratio if the firm uses $ \$5,000 $ of its cash to purchase additional inventory.

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Question 4

5 marks

A business currently holds $\$200,000$ in current assets, of which $\$120,000$ is inventory, against $\$80,000$ in current liabilities. Calculate the acid test ratio if the business liquidates $50\%$ of its inventory at cost to immediately settle an equivalent amount of its short-term debts, and explain why maintaining excessively high liquidity might lead to a lower Return on Capital Employed (ROCE).

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Question 5

5 marks

Global Logistics has provided a summary of its current assets and liabilities for two consecutive years to assess its liquidity position:

Year 2022: Current Assets = $\$80,000$; Current Liabilities = $\$40,000$; Inventory = $\$30,000$
Year 2023: Current Assets = $\$110,000$; Current Liabilities = $\$80,000$; Inventory = $\$60,000$

(a) Calculate the Current Ratio for both 2022 and 2023. [2]
(b) Calculate the Acid Test (Quick) Ratio for 2023. [1]
(c) Using your calculations, evaluate whether Global Logistics is in a stronger liquidity position in 2023 compared to 2022. [2]

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Question 6

8 marks

TechFlow Ltd. is a retail company specializing in high-end computer components. The following financial data has been extracted from its final accounts for the years ending 31 December 2022 and 31 December 2023:

Financial Information (all figures in \$):
- Sales Revenue (2022): $500,000$
- Sales Revenue (2023): $650,000$
- Cost of Goods Sold (2022): $250,000$
- Cost of Goods Sold (2023): $422,500$
- Current Assets (2022): $120,000$
- Current Assets (2023): $190,000$
- Inventory (2022): $40,000$
- Inventory (2023): $120,000$
- Current Liabilities (2022): $60,000$
- Current Liabilities (2023): $100,000$

(a) Calculate the Current Ratio and the Acid Test Ratio for both 2022 and 2023. (4 points)
(b) Calculate the Gross Profit Margin (GPM) for both 2022 and 2023. (2 points)
(c) Using your calculations and the provided data, evaluate the changes in liquidity and profitability for TechFlow Ltd. Explain how the change in inventory levels has specifically affected the company’s financial position. (2 points)

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