Explain why liquidity and profitability are important to a business.

Mark scheme

Marking points from the official mark scheme (Oct/Nov 2020). The mark or mark type is shown in brackets.

1. Award 1 mark for each relevant reason or explanation of the reason for liquidity and profitability:
2. Relevant reasons might include:
3. Liquidity:
4. Allows a business to see if it is able to pay back the short-term debts of the business
5. Measured by current ratio/acid test ratio
6. If it cannot pay the debts, then it will not be able to buy more inventory or raw materials
7. If the business becomes illiquid it may be forced to sell business assets to pay debts and will cease trading
8. Profitability:
9. It measures how well profit is being made from sales or capital invested in the business
10. Could be used to reinvest into the business/use retained profits for expansion
11. Measured by gross profit margin/profit margin/ROCE
12. It can be a measure of efficiency
13. Can compare business performance over time/compare against other businesses
14. It helps investors or bank to decide whether to invest in the business or lend it money
15. Retain shareholders/pay dividends/return on investment for the owners
16. Award a maximum of 3 additional marks for each explanation. This is a generic question, therefore there are no application marks available.
17. For example:
18. Profitability is a measure of performance (1) and can be used to show the bank so that it may give the business a loan for expansion. (1) It shows how efficiently the business is converting investment into profit (1) as shown by the percentage of profit to revenue or profit to investment in the business. (1)
19. Sound application of knowledge and understanding of relevant business concepts using appropriate terminology.
20. Detailed discussion of the two or more methods of sales promotion.
21. Well-justified recommendation.
22. Candidates discussing all three methods in detail, in context and with well-justified recommendation including why the alternative methods were rejected should be rewarded with the top marks in the band.
23. Relevant points might include:
24. Buy one get 50% off second purchase
25. Encourages customers to buy more jewellery - more sales to gain the second item at 50% reduction
26. But this will reduce the gross profit on the second item of jewellery – lower profit overall
27. Customers may perceive this as lower quality jewellery
28. 10% off everything in the shop for one week after opening
29. Encourages sales on all items of jewellery as reduction on all items
30. Less effect on gross profit than the 50% off (which will effectively be 25% reduction on each item)
31. However, slightly less gross profit on each item but this will also mean less gross profit paid to the franchisor
32. Pay a celebrity to open the shop
33. Many people may visit the shop to meet the celebrity - increasing sales while people are in the shop
34. Gains full gross profit on each item as opposed to the two alternative options
35. If customers like the jewellery then may visit the shop again later and sales may continue to increase
36. Increased cost of paying the celebrity to visit the shop which can be very expensive
37. Improved the image of the shop – as the shop may be associated with the celebrity and the luxury nature of GJs jewellery
38. Recommendation Justification might include:
39. Revenue is likely to increase in all three options. However, buy one get 50% off second purchase of jewellery will attract customers to the make more than one purchase leading to the highest increase in revenue. The second option may only gain a small increase in revenue because a 10% reduction in price is a small discount and may not encourage much more than a 10% increase in sales. Although the celebrity may attract customers to the shop it is a one day promotion and will only increase sales and revenue for one day.
40. A price reduction of 10% may be the most effective in maximising revenue by encouraging increased sales of all items of jewellery. The loss in revenue from the price reduction of 10% could then be more than compensated for assuming a higher than 10% increase in the number of jewellery sales.
41. Paying a celebrity may increase revenue the most because many people will be made aware of the shop and be attracted to its opening. Many of these people may then make purchases of jewellery when at the new shop which would not otherwise have been made, therefore increasing revenue by the highest amount.