Alpine Sports and Budget Bikes: Ratio-Based Lending Decision
Two sole traders, Alpine Sports and Budget Bikes, both sell bicycles. Summary figures for the year ended 31 March 2025: Alpine Sports: Sales $420,000, Cost of goods sold $252,000, Gross profit $168,000, Profit $42,000, Inventory $35,000, Accounts receivable $28,000, Total assets $210,000, Equity $120,000. Budget Bikes: Sales $300,000, Cost of goods sold $195,000, Gross profit $105,000, Profit $36,000, Inventory $48,000, Accounts receivable $12,000, Total assets $150,000, Equity $90,000. A bank is considering a $50,000 loan to one business. The bank requires a current ratio of at least 1.5 and a gross profit margin of at least 30%. Neither business provides a statement of financial position with current liabilities separately; assume current liabilities are $40,000 for Alpine and $30,000 for Budget. Alpine’s owner wants to expand; Budget’s owner wants to reduce inventory.
1. Calculate the gross profit margin, profit margin, inventory turnover (using cost of goods sold / closing inventory) and current ratio for each business.
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Alpine Sports:
- Gross profit margin = $168,000 / $420,000 = 40.0%
- Profit margin = $42,000 / $420,000 = 10.0%
- Inventory turnover = $252,000 / $35,000 = 7.2 times
- Current assets = $35,000 + $28,000 = $63,000; current ratio = $63,000 / $40,000 = 1.58:1
Budget Bikes:
- Gross profit margin = $105,000 / $300,000 = 35.0%
- Profit margin = $36,000 / $300,000 = 12.0%
- Inventory turnover = $195,000 / $48,000 = 4.06 times
- Current assets = $48,000 + $12,000 = $60,000; current ratio = $60,000 / $30,000 = 2.00:1
2. Recommend which business the bank should lend to, using the ratios and the bank’s requirements. Justify your answer with reference to at least two ratios and one limitation.
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Both businesses meet the bank’s minimum gross profit margin of 30% and current ratio of 1.5. Alpine has the higher gross profit margin (40% vs 35%) and much faster inventory turnover (7.2 vs 4.06), which suggests efficient stock management. Budget has the higher profit margin (12% vs 10%) and stronger current ratio (2.00 vs 1.58), so it is more liquid and better able to meet short-term debts. Recommendation: Budget Bikes if the bank prioritises liquidity and profit margin; Alpine Sports if the bank prioritises gross margin and stock turnover. The purpose of the loan matters: a loan to reduce inventory may suit Budget; a loan to expand may suit Alpine. Limitation: ratios use historical cost and closing inventory, which may not represent average stock; they also ignore cash flow and security.
3. Explain why comparing the two businesses using only these ratios may be misleading.
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The businesses may use different accounting policies, such as FIFO versus weighted average for inventory, which changes cost of goods sold and closing inventory. Their assets may be different ages, and one may lease assets rather than own them. They may have different seasonality or customer bases. Ratios also ignore cash flow, loan security, owner experience, and local competition. A single year’s figures may not be representative.