Assessing Competitiveness
Unit 3: Business Decisions and Strategy
Assessing Competitiveness
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The statement of comprehensive income shows a year of trading: revenue, and the costs taken from it step by step, down to the profit for the year.
The statement of comprehensive income (the profit and loss account) records a business's trading over one year. Its key information is a cascade: each line takes one kind of cost away from the line above.
Orla Bakeries, a Hong Kong bakery chain, sold $40m of bread and cakes this year. Cost of sales was $24m, leaving gross profit of $16m. After $10m of other operating expenses, operating profit was $6m; after $0.8m of interest, the profit for the year was $5.2m.
Reading the statement means comparing lines, not quoting them. Revenue rose by a quarter, from $32m, but the profit for the year rose only from $4.8m: costs grew faster than sales, and interest quadrupled.
Real Example: A Nairobi café chain reports higher revenue every year, yet its profit for the year stays flat: the rent on its outlets, an operating expense, climbs as fast as its sales.
Exam Matters: Name the line you are using — gross profit, operating profit or profit for the year — and say which costs have already been taken off it. Using the wrong profit line changes every ratio built on it.
The statement of financial position is a snapshot of one day: what the business owns, what it owes, and the owners' money that funds the difference.
The statement of financial position (the balance sheet) shows the business on the last day of its financial year. Its key information comes in parts that always balance.
Assets minus liabilities gives net assets, and net assets always equal total equity. At the end of this year Orla had non-current assets of $29m and current assets of $6m, against current liabilities of $5m and bank loans of $10m due in later years: net assets of $20m, matched by total equity of $20m.
A year earlier its non-current assets were $18.5m and its long-term loans $2.5m. The $10.5m rise is a new central bakery, and the $7.5m of new borrowing shows that most of it was paid for with a loan.
Real Example: A Penang electronics distributor holds most of its assets as stock and money owed by customers. On the last day of its year it was owed more by customers than it owed its own suppliers.
Exam Matters: When a case gives a statement of financial position, say what a change in a line means for the business — a larger loan means more interest to pay — rather than only reporting that the figure went up.
Each stakeholder reads the same two statements for a different reason, so each looks first at the lines that answer its own question.
Stakeholder interest in the financial statements depends on what each group wants from the business.
Orla's bank lent more this year, so it will watch whether operating profit of $6m keeps covering interest of $0.8m comfortably. It does, seven and a half times, against twenty-five times a year earlier. Its flour suppliers care more that current liabilities have risen to $5m.
Real Example: Before extending a loan to a Dubai catering firm, a bank asks for two years of statements and checks how many times operating profit covers interest, not how fast revenue grew.
Exam Matters: Name the stakeholder, the statement and line it would read, and the decision it is making. "The bank would compare operating profit with interest before lending again" is stronger than "stakeholders are interested in the accounts".
A margin turns a profit figure into a share of revenue, so firms of different sizes, and one firm in different years, can be compared fairly.
Profit in dollars grows with the size of a business. Profitability ratios divide a profit figure by revenue to show how many cents of each dollar of sales are kept.
Orla's gross profit margin fell from 45% ($14.4m ÷ $32m) to 40% ($16m ÷ $40m). Each dollar of bread now carries more direct cost: flour prices rose, and a supermarket contract was won at lower prices.
Its profit for the year margin fell from 15% to 13%, less than the gross margin, because operating expenses grew more slowly than sales, although interest took a bigger share.
The gap between the two margins shows where money goes after production. A gross margin that falls points at buying, making or pricing; a profit for the year margin that falls further points at overheads or interest.
Real Example: A Singapore bubble-tea chain keeps a gross margin near 70% because its ingredients are cheap, yet its profit for the year margin is thin: prime outlets and staff absorb most of the difference.
Exam Matters: Show the working, give the result to one decimal place, and then say what caused the change using the case. A margin quoted without a reason tells a manager nothing.
Liquidity ratios ask whether short-term assets can pay the bills falling due within a year; the acid test asks it without counting stock.
A business can be profitable and still fail if it cannot pay what it owes this month. Liquidity ratios compare what will turn into cash within a year with what must be paid within a year.
The acid test leaves out inventory because stock may be slow to sell, or sell only at a discount, when cash is needed quickly.
Orla's current ratio fell from 1.5:1 to 1.2:1, and its acid test from 1:1 to 0.7:1: without its stock, it has 70 cents of liquid assets for each dollar due within a year.
Whether that is a problem depends on the business. A bakery sells for cash every day and its stock lasts days, so money keeps arriving before bills fall due; many food retailers run an acid test below 1:1 safely. A furniture maker that waits months to sell its stock and be paid could not.
Real Example: A Lagos supermarket group runs a current ratio below 1:1 for years without trouble: shoppers pay at the till, while its suppliers wait sixty days to be paid.
Exam Matters: Say what the figure means for this business before calling it good or bad: compare it with last year and with the kind of business it is, and say whether bills can be met as they fall due.
Gearing measures the share of a business's long-term finance that is borrowed; the higher it is, the more of its profit is promised to lenders first.
Capital employed is the long-term finance a business uses: non-current liabilities plus total equity. The gearing ratio shows how much of it is borrowed.
Orla borrowed to build its central bakery. Its long-term loans rose from $2.5m to $10m and total equity from $17.5m to $20m, so capital employed rose from $20m to $30m and gearing from 12.5% to 33.3%.
Borrowed money has to be serviced whatever happens to sales: interest is due every year and the loan must be repaid. Shareholders are paid only from what is left. So a highly geared business carries more financial risk; gearing above about 50% is usually described as high.
Low gearing is not automatically better. A firm that never borrows may grow more slowly than it could, and its owners must put in all the money themselves.
Real Example: A Kuala Lumpur property developer funds most of each project with bank loans, so a year of slow sales leaves it paying the same interest out of far less revenue.
Exam Matters: Connect gearing to the case: what the loan was for, what interest rates are doing, and how steady the firm's sales are. The same gearing ratio is more worrying when rates are rising or sales are uncertain.
ROCE measures the operating profit earned on all the long-term money invested in a business, so it can be compared with what that money could earn elsewhere.
Return on capital employed (ROCE) links the two statements: operating profit from the statement of comprehensive income, capital employed from the statement of financial position.
Operating profit is used, not profit for the year, because capital employed includes the lenders' money as well as the owners'. The return is measured before either group is paid.
Orla's ROCE fell from 25% ($5m ÷ $20m) to 20% ($6m ÷ $30m). Operating profit rose by $1m, but the money tied up in the business rose by $10m: the new bakery has not yet earned as much per dollar as the rest of the business.
A falling ROCE after a large investment is common. The new asset counts in full from the day it is bought, while the profit it brings builds up over later years.
Real Example: A Karachi logistics firm buys a fleet of new trucks. Its ROCE drops in the year of purchase, then climbs as the trucks win contracts over the following three years.
Exam Matters: Say what the ROCE is compared with — last year, a rival, or the interest rate on borrowing. A ROCE on its own says little about whether an investment was worth making.
A ratio becomes useful when it is compared: with last year, with rivals, and with what the money could cost or earn elsewhere. The comparison points to a decision.
Ratios assess competitiveness because they show whether a business turns its sales and its capital into profit as well as its rivals do. To interpret ratios to make business decisions, compare each one with something that gives it meaning:
That third comparison decides whether borrowing to invest makes sense. Orla pays 8% on its loans. With a ROCE of 20%, each dollar borrowed and invested earns about 20 cents of operating profit and costs 8 cents in interest, so the owners keep the difference. If ROCE fell below 8%, every borrowed dollar would cost more than it earned, and more borrowing would cut the profit left for shareholders.
The margins point to different decisions. Orla's gross margin fell because of flour prices and a low-priced contract, so its managers might renegotiate flour supplies or review the contract's price before cutting costs in the shops.
Real Example: A Bangkok hotel group earning a ROCE of 6% while its loans cost 9% decides to sell two hotels and repay debt rather than build a third.
Exam Matters: End an interpretation with the decision it supports: borrow or not, which costs to cut, which price to change. A ratio that is calculated and described but never used for a decision stops halfway.
Liquidity says whether the business can pay this year's bills; gearing says how much risk its financing carries. Together they shape how the next investment is paid for.
Liquidity and gearing answer different questions, and each points to different decisions.
Orla now has gearing of 33.3% and an acid test of 0.7:1. Neither is alarming for a bakery with daily cash sales and loans costing less than its ROCE. But a second loan-financed bakery would first add interest owed to the bank every month; then, at the year end, the statement of financial position would show gearing pushed higher; and if sales fell in the year after that, the interest would still be owed. Issuing new shares would keep gearing down, at the cost of sharing future profit with more owners.
Real Example: A regional airline with gearing near 70% sees fuel prices jump. Its payments to lenders cannot be cut, so it raises money by selling two aircraft and leasing them back rather than borrowing again.
Exam Matters: Use two ratios together. A firm with high gearing and weak liquidity has a sharper problem than either figure shows alone, and a recommendation should say which it fixes first.
Ratios describe the past in numbers the business prepared itself, so they show that something has changed but rarely why, and never what the numbers leave out.
The limitations of ratio analysis are what a careful reader states alongside every ratio:
Orla's ROCE fell after it built its bakery. The ratio alone cannot say whether that was a mistake or an investment that will pay off over the next ten years; the plan behind it can.
Real Example: A Jakarta retailer's current ratio looks strong on its reporting date because it held back every payment it could in the final fortnight. A month later, with the bills settled, the ratio is well below its published figure.
Exam Matters: When asked how useful ratios are, apply the limitations to the case in front of you — which figure could be window-dressed, what the ratios cannot see — rather than listing every limitation you know.
Labour productivity measures output per worker over a period. Higher productivity spreads each wage over more output, lowering the labour cost of every unit.
It is calculated for a period — a week, a month, a year — and for a group whose output can be counted: loaves baked, calls answered, rooms cleaned.
Orla's central bakery made 128,000 loaves a month with 40 bakers last year: 3,200 each. This year 50 bakers made 150,000: 3,000 each. Output rose, but productivity fell by about 6%.
Interpreting it means asking why. New bakers still learning, old ovens beside new ones, or flour arriving short on some days would each lower output per worker. The decision depends on the cause: training, new equipment, or better planning.
Productivity matters for competitiveness because wages are paid per worker, not per loaf. If each baker earns the same and makes fewer loaves, the labour cost of every loaf rises.
Real Example: A Manila call centre measures calls resolved per agent per shift. When it doubled its agents in one month, calls per agent fell for six weeks while the new staff learned the systems.
Exam Matters: Give the figure with its unit — loaves per baker per month — and compare it with an earlier period or a similar business before saying what it shows.
Labour turnover compares the staff who leave with the average workforce; retention asks how many of those there at the start of a year are still there at its end.
The two are not mirror images. Turnover counts every leaver, including new starters who went within weeks; retention follows only the people who were already there. A firm can lose many new recruits and still keep its experienced staff.
In Orla's shops, 27 of an average 180 staff left last year: turnover of 15%. This year 60 of 200 left: 30%. Of the 190 staff employed at the start of this year, 152 were still there at the end, a retention rate of 80%, down from 90%.
Each leaver costs $8,000 to replace in advertising, interviews and training, so turnover cost about $480,000 this year against $216,000 the year before, before counting slower service while new staff learn. Some turnover helps: it brings in new ideas and lets poor performers go.
Real Example: A fast-food chain in Riyadh finds that most of its leavers quit within their first three months. It pairs each new starter with an experienced worker, and within a year far fewer quit early.
Exam Matters: Put a cost on turnover where the case allows — leavers × the cost of replacing one — and weigh it against what it would cost to keep staff. The comparison is what turns a percentage into a decision.
Absenteeism measures the share of possible working days lost because staff were absent. A rising rate adds cost and is often a sign of deeper problems at work.
Possible working days are the number of staff multiplied by the days each is due to work. In Orla's shops, 200 staff each due to work 250 days give 50,000 possible days. 2,500 were lost to absence: a rate of 5%, up from 3% (1,350 of 45,000).
Absence costs twice. The absent worker may still be paid, and someone else must cover the shift, often on overtime, or the shop runs short-staffed and queues grow. Frequent short absences are also an early warning: they tend to rise with low morale, poor management or stressful shift patterns, the same causes that later push people to quit.
The decision depends on the pattern. Absence concentrated in one shop points to its manager; absence on particular days points to rotas; long absences may be genuine illness that needs support rather than pressure.
Real Example: A private hospital in Doha finds that absence among night-shift nurses is double the day-shift rate. It changes the rota so no one works more than three nights in a row, and absence falls.
Exam Matters: Link absenteeism to cost and to the other measures in the case. A rise alongside rising turnover suggests one cause behind both, and a strategy aimed at that cause.
Workforce measures show how much output, staff and time a business has gained or lost, but not why, and each can hide the detail that matters for a decision.
Labour productivity, labour turnover, retention and absenteeism share the limitations of these calculations:
So Orla's managers would read the figures beside other evidence: exit interviews with leavers, staff surveys, and the pattern by shop and shift.
Real Example: A software firm in Bengaluru reports falling labour turnover. Exit interviews show the problem it hides: the staff still going are its most skilled engineers, hired away by rivals.
Exam Matters: When a question asks how useful the data are, pair each figure with what it cannot show in this case, and name the extra evidence — exit interviews, surveys, shop-by-shop figures — that would fill the gap.
Financial rewards pay staff more, or pay them for results, attendance or loyalty. They act quickly, but the cost rises with every worker and the effect can fade.
Financial rewards are the most direct human resource strategy: change what people are paid, or what they are paid for.
Orla pays shop staff $2,000 a month; its two largest rivals pay $2,200. Closing the gap for 200 staff would cost about $480,000 a year, the same as the $480,000 that turnover now costs. No pay rise keeps every leaver, so fewer leavers alone cannot repay it. The case for it rests on what else it brings, such as experienced staff who serve customers better; a smaller reward aimed at the staff most likely to leave costs less.
The limits: pay rises are hard to reverse, an output bonus can reward speed over quality, and money does little if people are going because of how they are managed.
Real Example: A laundry chain in Cairo pays each team a monthly bonus if it hits its target with no complaints. Output per worker rises, and the no-complaints condition stops quality being traded for speed.
Exam Matters: Cost the reward where you can and set it against the cost of the problem it targets. A reward that costs more than the turnover it prevents needs another justification, such as better service.
Employee share ownership gives or sells staff shares in the business, so they gain when it does well. Shares that vest only after years of service also reward staying.
In an employee share ownership scheme, staff receive shares free, as part of a bonus, or buy them at a discount. As owners, they receive dividends and gain if the share price rises.
The aim is to make employees think like owners: if the business does well, so do they, which can lift effort, co-operation and productivity. Schemes often make shares vest only after a set period — two or three years — and anyone who quits earlier forfeits them, which gives staff a strong reason to stay.
Orla's directors are considering a scheme costing about $500,000 a year, close to the $480,000 that labour turnover cost this year. Even if no one left, that saving would not cover it, so the scheme must also be worth something the turnover figure leaves out, such as keeping the most experienced staff.
The limits. Each worker's shares are a small part of the whole, so one person's effort barely moves the share price and the link between effort and reward is weak. Share prices can fall for reasons staff do not control. Issuing new shares dilutes existing owners, and in a family company, giving shares to staff means sharing control.
Real Example: A Singapore engineering firm gives every employee shares that vest after three years. Resignations fall sharply in the second and third years of service, then return to normal once the shares are theirs.
Exam Matters: Say what the scheme is for in this case — keeping staff, or raising effort — and whether its design (vesting, size of award) fits that aim. Weigh it against simpler rewards that act faster.
Consultation means asking staff for their views before a decision is made. Managers still decide, but decisions improve and staff feel heard.
Consultation strategies give employees a voice before managers decide: staff meetings, suggestion schemes, surveys, and elected staff representatives or committees that meet managers regularly.
It works on several measures at once. Staff who are asked about changes that affect them — new rotas, new equipment, new targets — are more likely to accept them, so fewer quit in frustration and fewer take days off when morale is low. The people doing the work often know where time is wasted, so their suggestions can raise productivity.
Orla's leavers were asked why they went. Most mentioned pay, but many said that shift rotas were changed at a day's notice without anyone asking them. Consulting shop staff before rotas are set costs little compared with a pay rise.
The limits. Consultation is slower than simply deciding. It raises expectations, and staff who are asked and then ignored may be more frustrated than if they had never been asked. Managers keep the final decision, so staff gain influence, not control.
Real Example: A Colombo garment factory sets up a monthly committee of elected machinists and managers. Its first change, moving breaks out of the hottest hour, costs nothing, and afternoon absence falls.
Exam Matters: Say who decides and how often staff are consulted in the case. Consultation that is regular and acted on is a strategy; a single survey is not.
Empowerment gives staff the authority to make decisions about their own work within agreed limits, so problems are solved where they happen.
Empowerment strategies go further than consultation: employees are given the authority to decide, not only to advise. A shop team might set its own rota, decide how to handle a complaint, or reorder stock without waiting for a manager.
Empowered staff can act at once, so customers are served faster and managers are freed for other work. Control over one's own work motivates many people, which can raise productivity and make them less likely to quit or to take unnecessary days off.
Orla could let each shop's team agree its own rota within the hours the shop must be staffed — the very decision its leavers complained about.
The limits. Empowerment needs training and trust: staff given decisions without the skills or information to make them may make costly mistakes. Some employees do not want the responsibility. Managers must accept losing some control, and in a large chain, standards can drift between shops.
Real Example: A hotel in Mauritius lets front-desk staff spend up to a set amount to put right any guest complaint without asking a manager. Complaints are settled faster, and staff say they feel trusted.
Exam Matters: Judge empowerment against the workforce in the case: its skills, experience and turnover. It suits settled, trained teams better than a workforce where most staff are new.
The statement of comprehensive income shows a year of trading: revenue, and the costs taken from it step by step, down to the profit for the year.
The statement of financial position is a snapshot of one day: what the business owns, what it owes, and the owners' money that funds the difference.