The Declining Performance of Seri Wangi Boutique

Analysis and Interpretation of Financial Statements for Decision Making

Skill: Analyse

Stimulus

Question

(a) Seri Wangi Boutique's sales rose but its net profit fell. Analyse TWO possible causes of this situation based on the given ratios.

(b) Explain the effect of the changes in the current ratio and inventory turnover on the business's cash position.

(c) Based on your analysis, explain why rising sales still led to a falling bank balance.

Thinking steps

1. Compare gross profit margin: it fell from 40% to 32%, meaning cost of sales rose faster than sales or selling prices were cut.
2. Compare net profit margin: it fell from 18% to 9%, a bigger drop than the gross margin, showing operating expenses also rose.
3. Interpret inventory turnover: it fell from 6 times to 3 times, meaning stock moves more slowly and capital is tied up in inventory.
4. Interpret the current ratio: it fell from 2.4:1 to 1.3:1, showing a weakening ability to pay short-term debts.
5. Link cause and effect: shrinking profit, accumulated stock and tied-up cash cause slow cash inflow despite high sales.

Model answer

(a) Cause 1: Gross profit margin fell from 40% to 32%. This shows cost of sales rose faster than sales (e.g. purchase prices of clothing increased) or Puan Halimah cut selling prices to attract customers. Cause 2: Net profit margin fell more sharply (18% to 9%) than the gross margin, showing that operating expenses such as rent, wages or advertising also rose. High cost of sales plus high expenses eroded profit despite higher sales.

(b) Inventory turnover fell from 6 times to 3 times, meaning stock takes longer to sell, so cash is tied up in unsold inventory. The current ratio fell from 2.4:1 to 1.3:1, showing current assets are now barely above current liabilities, so the business struggles to pay creditors on time; this explains why suppliers are pressing for payment.

(c) Sales rose, but much of the increase may be credit sales or sales at low margins, while cash was used to buy and hold slow-moving stock and to pay rising expenses. Cash therefore flowed out faster than it came in, causing the bank balance to fall despite high sales. Recommendation: control purchase costs, reduce stock purchases, and tighten debt collection.