5.4.5 Practical use of ratio analysis

Question 1

evaluation of ways to increase profit margins

Answer 1

lets gooo

Question 2

a)increase gross and operating profit margin by reducing direct costs

Answer 2

1. use cheaper materials for eg rubber not leather on soles of shoes BUT (evaluation) consumer’s perception of quality may be damaged and this could hit prod’s reputation. Consumers may expect lower prices,which may cut the gross profit margin.
2. Cutting labour costs eg relocating production to low labour cost countries,such as dyson making vacuum cleaners in malaysia BUT quality may be at risk ; communication problems with distant countries
3. cutting labour costs by increasing productivity through automation for eg hyundai’s prod line uses some of the most labour-saving robots in the world BUT i)purchasing machinery will inc overhead costs(gross profit rise but operating profit will fall aka $1000 ki machine wouldnt be included in direct costs it will be included in overheards) ii)remaining staff will need retraining so short term profits will fall
4. cutting wage costs by reducing worker’s pay BUT motivation levels might fall which could reduce productivity and quality

Question 3

b) increase gross and operating profit margin by increasing price

Answer 3

1. raising the price of a product with no significant increase in variable costs for eg mauritius telecom raising the price of its broadband connection BUT total profits fall if too many customers switch to competitors -this links it to elasticity.
2. petrol companies increasing prices by more than the price of oil has risen BUT consumers may consider this to be a ‘profiteering’ decision and the long term image of the business may be damaged.

Question 4

c)increase operating profit margin by reducing overhead costs

Answer 4

cutting overhead costs such as rent,promo costs or management costs but maintaining sales levels

i) moving to a cheaper head office location BUT lower rental costs could mean moving to a cheaper area
ii) reducing promo costs BUT cutting promo costs could lead to sales falling more than fixed costs
iii) delayering the organisation BUT fewer managers-or lower salaries-could reduce the efficient operation of the business.