Statements and analysis

Financial ratios

A figure alone means nothing; the comparison does.

Draft: not yet reviewed by a teacher

Why it exists

Is a profit of 100,000 a lot? For a stall, yes; for a chain of shops, no. Ratios turn amounts into percentages, days and times, so two pharmacies of different sizes can be compared and a bank can see which will repay a loan.

Key rules

Return on capital employed (ROCE) = profit before financing and income taxes (IFRS 18; formerly called profit before interest and tax) / capital employed (equity + non-current liabilities) × 100%.
Gross margin = gross profit / revenue; operating margin = operating profit / revenue. With no investment income, operating profit equals profit before financing and income taxes, and then ROCE = operating margin × asset turnover (revenue / capital employed).
Liquidity: current ratio = current assets / current liabilities; quick ratio = (current assets − inventory) / current liabilities.
Efficiency: inventory days = inventory / cost of sales × 365; receivables days = receivables / revenue × 365; payables days = payables / purchases (or cost of sales) × 365.
Position: gearing = debt / (debt + equity) or debt / equity; interest cover = profit before financing and income taxes / finance costs.
Interpretation: state the change, explain it with facts from the scenario and say what it means for the user. A formula without a reason earns no marks.

Examples

A Bakı pharmacy: revenue 800,000, cost of sales 560,000, operating expenses 144,000, interest 16,000; equity 400,000, a long-term loan 200,000; inventory 70,000, receivables 40,000, cash 10,000, current liabilities 80,000.

Gross margin: 240,000 / 800,000 = 30%
Operating margin: 96,000 / 800,000 = 12%
ROCE: 96,000 / 600,000 = 16% (= 12% × 1.33 asset turnover)
Current: 120,000 / 80,000 = 1.5 : 1; quick: 50,000 / 80,000 = 0.63 : 1
Inventory days: 70,000 / 560,000 × 365 = 45.6; receivables days: 40,000 / 800,000 × 365 = 18.3
Gearing: 200,000 / 600,000 = 33.3%; interest cover: 96,000 / 16,000 = 6 times

A set of ratios for one company

How it works

Ratios are linked: a higher ROCE can come from margin (selling at higher prices) or from turnover (selling more on the same capital). Longer receivables days mean less cash and may lower the quick ratio. So read each ratio alongside the others.

Use the definitions the question gives: in the exam a formula is sometimes specified (for example, average or closing inventory).

Traps

Taught in the course

Key rules

Return on capital employed (ROCE) = profit before financing and income taxes (IFRS 18; formerly called profit before interest and tax) / capital employed (equity + non-current liabilities) × 100%.

Gross margin = gross profit / revenue; operating margin = operating profit / revenue. With no investment income, operating profit equals profit before financing and income taxes, and then ROCE = operating margin × asset turnover (revenue / capital employed).

Liquidity: current ratio = current assets / current liabilities; quick ratio = (current assets − inventory) / current liabilities.

Efficiency: inventory days = inventory / cost of sales × 365; receivables days = receivables / revenue × 365; payables days = payables / purchases (or cost of sales) × 365.

Position: gearing = debt / (debt + equity) or debt / equity; interest cover = profit before financing and income taxes / finance costs.

Interpretation: state the change, explain it with facts from the scenario and say what it means for the user. A formula without a reason earns no marks.