Why is "Using Sales instead of Cost of Sales in inventory turnover." a common mistake in The calculation and interpretation of accounting ratios?

Why it happens: Reflex to use Sales for most ratios. How to avoid it: Inventory is valued at COST, so inventory turnover MUST use Cost of Sales as numerator. Sales has a profit margin built in. Source: Edexcel 4AC1 examiner reports.

Why is "Quoting inventory turnover in DAYS when 'times' is asked (or vice versa)." a common mistake in The calculation and interpretation of accounting ratios?

Why it happens: Forms confusion. How to avoid it: Times = COGS ÷ Inventory. Days = 365 ÷ Times = Inventory ÷ COGS × 365.

Why is "Using TOTAL sales instead of CREDIT sales in receivables days." a common mistake in The calculation and interpretation of accounting ratios?

Why it happens: Students don't separate cash from credit. How to avoid it: TR Collection Period is about customer credit — use CREDIT sales only (if disclosed). If only total sales are given, use total (with a note).

Why is "Forgetting to subtract inventory in the Acid Test." a common mistake in The calculation and interpretation of accounting ratios?

Why it happens: Confusion with Current Ratio. How to avoid it: Acid Test = (CA − Inventory) ÷ CL. Current Ratio = CA ÷ CL. They differ ONLY in the inventory deduction.

Why is "Forgetting × 100 when calculating percentages." a common mistake in The calculation and interpretation of accounting ratios?

Why it happens: Time pressure. How to avoid it: If the ratio is a %, the formula ends in × 100. Drill this.

Why is "Calculating ratios but failing to INTERPRET them." a common mistake in The calculation and interpretation of accounting ratios?

Why it happens: Students treat ratio questions as arithmetic. How to avoid it: Interpretation = link to a business cause/effect. 'GP margin fell because cost of inputs rose / selling prices fell / inventory write-down occurred.'

Why is "Saying 'rising current ratio is bad'." a common mistake in The calculation and interpretation of accounting ratios?

Why it happens: Confusion about preferred direction. How to avoid it: Liquidity ratios: UP = better (more cushion). Days ratios: UP for receivables/inventory = WORSE (slower). Up for payables can be good (more time to pay) but also signals cash flow strain.

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The calculation and interpretation of accounting ratios

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Accounting Ratios — Edexcel IGCSE Accounting (4AC1) Detailed Notes

12+ ratios across four families — profitability, liquidity, efficiency, and capital structure. Master the formulae, the interpretation, and the recommendation framework.

What you’ll learn

Mapped to the Pearson Edexcel IGCSE 4AC1 syllabus (2026 onwards).

Calculate ratios across all four families.
Interpret ratio results: identify favourable vs unfavourable trends.
Compare ratios over time (trend analysis) and between businesses (inter-firm).
Identify possible CAUSES of changes in each ratio.
Recommend actions to improve specific ratios.
Make business decisions (lend/invest/extend credit) based on ratio analysis.

The four ratio families — what each measures

Profitability, Liquidity, Efficiency, Capital Structure.

1. Profitability — how profitable is the business?

GP Margin, Profit Margin, Mark-up, ROCE.

2. Liquidity — can the business pay its short-term debts?

Current Ratio, Acid Test (Quick) Ratio, Working Capital.

3. Efficiency / Activity — how effectively are resources used?

Inventory Turnover, TR Collection Period, TP Payment Period.

4. Capital Structure — how is the business financed?

Gearing Ratio.

Each family answers a specific question. A complete ratio analysis touches all four.

Profitability ratios — explained

How much profit per £ sales or per £ capital invested.

Gross Profit Margin = (GP ÷ Sales) × 100. Measures profit before operating expenses. Industry norms vary widely (retail 20–40%; supermarkets 10–15%).

Mark-up = (GP ÷ COGS) × 100. The 'markup' over cost. Linked to GP Margin (see incomplete records — convert one to the other).

Profit Margin (Net) = (Profit ÷ Sales) × 100. Captures the effect of all operating expenses.

ROCE = (Profit ÷ Capital Employed) × 100. The 'return on investment' — how much profit per £1 of long-term capital. The most important profitability ratio for owners and investors.

Possible causes of changes:

GP Margin ↓: rising costs, falling prices, theft/inventory write-down.
Profit Margin ↓: rising expenses (e.g., wages, depreciation, rent).
ROCE ↓: profit fell OR capital base rose without commensurate profit growth.

Liquidity ratios — explained

Can short-term debts be paid?

Current Ratio = CA ÷ CL. Healthy 1.5–2.0:1. Too high may indicate excess inventory or slow receivables.

Acid Test (Quick) Ratio = (CA − Inventory) ÷ CL. More stringent — excludes inventory because it may take time to sell. Healthy ≥ 1:1.

Working Capital = CA − CL. The absolute £ of cushion.

Why two liquidity ratios?

Current ratio assumes inventory can be quickly converted to cash.
Acid test removes that assumption — more conservative.

A business with current ratio 2.0 but acid test 0.5 has lots of inventory tied up. It may face a liquidity crisis if sales slow.

Efficiency ratios — explained

How well does the business manage its working capital?

Inventory Turnover (times) = COGS ÷ Average Inventory. How many times inventory is sold and replaced per year.

Inventory Days = (Avg Inv ÷ COGS) × 365 = 365 ÷ Inventory Turnover. How long inventory sits.

Trade Receivables Collection Period = (TR ÷ Credit Sales) × 365. How fast customers pay. Industry norms 30–60 days.

Trade Payables Payment Period = (TP ÷ Credit Purchases) × 365. How fast the business pays suppliers.

Cash Operating Cycle = Inventory Days + TR Days − TP Days. The time between paying for inventory and collecting from customers. Shorter = better.

Possible causes of changes:

Inventory days ↑: obsolete stock, demand drop, over-ordering.
TR days ↑: poor credit control, customer distress, longer credit terms offered.
TP days ↑: cash flow strain, deliberate stretching, supplier dispute.

Capital structure — Gearing

How reliant is the business on long-term debt?

Gearing Ratio = (Long-term debt ÷ Capital Employed) × 100.

Low (<30%): low financial risk, conservative.
Moderate (30–50%): balanced.
High (>50%): more financial risk; more interest cost.
Very high (>80%): potentially dangerous.

Why gearing matters:

Higher gearing → higher interest payments → more financial risk if profits fall.
BUT also higher 'leverage' — small profit increases magnify ROCE.
Lower gearing → safer but possibly under-leveraged for growth.

Lenders use gearing to assess loan risk; investors use it to assess return potential.

Interpreting ratios — the A* framework

Calculate → Compare → Cause → Consequence → Action.

Standard interpretation framework:

Calculate the ratio.
Compare with prior year / industry / competitor benchmarks.
Identify the CAUSE of any change.
State the CONSEQUENCE for the business.
Recommend an ACTION to address it.

Example: TR Collection Period rose from 30 to 60 days.

Cause: poor credit control / slow-paying customers / extended credit terms.
Consequence: cash flow strain; possibly need for overdraft or postpone payments.
Action: tighten credit control, offer settlement discounts, factor receivables.

The five-step chain — generic 'ratio got worse' answers cap in the lowest band; cause → consequence → action wins A* marks.

Generic 'ratio got worse' answers cap in the lowest mark band. Cause-and-effect chains earn AO3 marks.

Limitations of ratio analysis

Ratios are useful but not the whole story.

Ratios are a starting point, not a conclusion. Limitations include:

Historical — based on past data; future may differ.
One snapshot — doesn't show trends within the year (seasonality).
No qualitative info — staff morale, customer satisfaction, brand strength aren't captured.
Industry-dependent — what's normal in retail isn't normal in construction.
Manipulation — accounting choices (depreciation method, inventory valuation) affect ratios.
Inter-firm comparison difficulty — different policies, sizes, structures.
Inflation — distorts year-on-year comparisons.

A* candidates briefly note 1-2 limitations in extended responses — shows critical thinking.

How it’s examined

Paper 1: Calculate specified ratios (4–8 marks each); state preferred direction.

Paper 2: Calculate AND interpret 4–6 ratios in a single 15–20 mark question. AO3 marks for cause-effect-action analysis. Frequently combined with a recommendation question (lend / invest / extend credit).

Sources: Pearson Edexcel International GCSE in Accounting (4AC1) Specification — Issue 3; Edexcel 4AC1 Examiner Reports (2022–2024). Last reviewed 2026-05-19.

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Step-by-step worked examples — The calculation and interpretation of accounting ratios

Step-by-step solutions to past-paper-style questions on the calculation and interpretation of accounting ratios, written exactly the way a tutor would explain them at the board.

1Classify each ratio by family
Getting started• Edexcel 4AC1 style — short-answer (6 marks)• ratio-families, AO1
Question
Classify each ratio as PROFITABILITY, LIQUIDITY, EFFICIENCY or CAPITAL STRUCTURE: (a) Gross profit margin (b) Current ratio (c) Inventory turnover (d) Return on Capital Employed (ROCE) (e) Trade receivables collection period (f) Gearing ratio
Step-by-step solution
1. Step 1
  Each ratio answers a specific business question.
Answer
(a) Profitability (how much profit per £ sales).

(b) Liquidity (can short-term debts be paid?).

(c) Efficiency (how quickly is inventory sold?).

(d) Profitability (return on owner's investment).

(e) Efficiency (how quickly customers pay).

(f) Capital structure (how reliant on borrowing?).
Examiner tip
Each family answers a specific business question. Profitability = how profitable; Liquidity = can it pay debts; Efficiency = how well are resources used; Capital Structure = how is it financed.
2Match each ratio to its formula
Building confidence• Edexcel 4AC1 style — short-answer (5 marks)• formulas, AO1
Question
Match each ratio name to the correct formula: (a) Current Ratio. (b) Gross Profit Margin. (c) Acid Test Ratio. (d) Trade Payables Payment Period. (e) Inventory Turnover (times).
Step-by-step solution
1. Step 1
  Match by definition.
Answer
(a) Current Assets ÷ Current Liabilities.

(b) (Gross Profit ÷ Sales) × 100.

(c) (Current Assets − Inventory) ÷ Current Liabilities.

(d) (Trade Payables ÷ Credit Purchases) × 365.

(e) Cost of Sales ÷ Average Inventory.
Examiner tip
Acid test EXCLUDES inventory (because inventory may be slow to sell). Current ratio INCLUDES it. Most stringent measure = acid test.
3Interpret whether each ratio result is favourable or unfavourable
Higher• Edexcel 4AC1 style — short-answer (6 marks)• interpretation, AO1, AO2, AO3
Question
State whether each scenario suggests an IMPROVEMENT or DETERIORATION in business performance: (a) Current ratio rose from 1.5:1 to 2.0:1. (b) Inventory turnover fell from 8 to 5 times. (c) Gross profit margin fell from 35% to 30%. (d) Trade Receivables collection period rose from 30 to 45 days. (e) Gearing ratio rose from 30% to 60%. (f) ROCE rose from 12% to 18%.
Step-by-step solution
1. Step 1
  Each ratio has a 'preferred direction'.
Answer
(a) Improvement in liquidity (more current assets per liability).

(b) Deterioration — inventory selling slower (less efficient).

(c) Deterioration — less profit per £ sales.

(d) Deterioration — customers paying slower (cash flow risk).

(e) Likely deterioration — higher reliance on borrowing = more financial risk.

(f) Improvement — better return on capital employed.
Examiner tip
Direction of 'good' depends on the ratio. Liquidity ↑ = good (usually). Margins ↑ = good. Turnover days ↑ = bad (slower). Gearing ↑ = riskier.
4Calculate the four profitability ratios
Building confidence• Edexcel 4AC1 style — calculation (8 marks)• profitability-ratios, AO1, AO2
Question
From: Sales £200,000; Cost of Sales £140,000; Profit for the year £25,000; Capital Employed £125,000. Calculate (a) Gross Profit Margin, (b) Profit Margin (Net), (c) Mark-up, (d) Return on Capital Employed (ROCE).
Step-by-step solution
1. Step 1
  Gross Profit = Sales − COGS = £60,000.
Answer
(a) GP Margin = (£60,000 ÷ £200,000) × 100 = 30%.

(b) Profit Margin = (£25,000 ÷ £200,000) × 100 = 12.5%.

(c) Mark-up = (£60,000 ÷ £140,000) × 100 = 42.86%.

(d) ROCE = (£25,000 ÷ £125,000) × 100 = 20%.
Examiner tip
Always calculate to 1 or 2 decimal places. Don't forget the × 100 — it's a percentage.
5Calculate the two liquidity ratios
Building confidence• Edexcel 4AC1 style — calculation (5 marks)• liquidity, AO1, AO2
Question
From: Inventory £15,000; Trade Receivables £8,000; Bank £3,000; Cash £500; Trade Payables £12,000; Bank Overdraft £2,000. Calculate (a) Current Ratio, (b) Acid Test (Quick) Ratio.
Step-by-step solution
1. Step 1
  Sum current assets and current liabilities.
Answer
Current Assets = £15,000 + £8,000 + £3,000 + £500 = £26,500. Current Liabilities = £12,000 + £2,000 = £14,000.

(a) Current Ratio = £26,500 ÷ £14,000 = 1.89 : 1.

(b) Acid Test = (£26,500 − £15,000) ÷ £14,000 = £11,500 ÷ £14,000 = 0.82 : 1.
Examiner tip
Acid test of <1 means current liabilities exceed liquid (non-inventory) assets — a potential liquidity concern.
6Calculate the efficiency ratios
Higher• Edexcel 4AC1 style — calculation (8 marks)• efficiency, AO1, AO2
Question
From: Cost of Sales £140,000; Average Inventory £12,000; Closing Trade Receivables £25,000; Credit Sales £180,000; Closing Trade Payables £18,000; Credit Purchases £150,000. Calculate (a) Inventory Turnover (times), (b) Inventory Holding Period (days), (c) Trade Receivables Collection Period, (d) Trade Payables Payment Period.
Step-by-step solution
1. Step 1
  Each ratio is either a turnover (times) or a period (days).
Answer
(a) Inventory Turnover = £140,000 ÷ £12,000 = 11.67 times.

(b) Inventory Holding Period = 365 ÷ 11.67 = 31.3 days (or £12,000 ÷ £140,000 × 365 = 31.3 days).

(c) TR Collection = (£25,000 ÷ £180,000) × 365 = 50.7 days.

(d) TP Payment = (£18,000 ÷ £150,000) × 365 = 43.8 days.
Examiner tip
Use Cost of Sales (not Sales) for inventory turnover — inventory is held at cost. Use Credit Sales/Purchases for receivables/payables periods.
7Calculate gearing and interpret
Higher• Edexcel 4AC1 style — calculation (5 marks)• gearing, AO1, AO2
Question
From: Long-term loan £40,000; Preference share capital £0; Ordinary share capital £80,000; Reserves £30,000. Calculate (a) Gearing ratio (Debt / Total Capital), (b) state whether the business is high or low geared.
Step-by-step solution
1. Step 1
  Gearing = Long-term borrowing ÷ Total Capital × 100.
Answer
Total Capital Employed = £40,000 + £80,000 + £30,000 = £150,000.

(a) Gearing = (£40,000 ÷ £150,000) × 100 = 26.7%.

(b) Low geared — most capital is equity-funded.

Guidelines: <30% = low; 30–50% = moderate; >50% = high; >80% = potentially risky.
Examiner tip
Low gearing = financial stability but possibly under-leveraged. High gearing = more growth potential but more risk.
8Interpret a full set of ratios for a business
Stretch• Edexcel 4AC1 style — extended (12 marks)• interpretation, AO1, AO2, AO3
Question
Two years' ratios for a business:

Ratio 2025 2026
GP Margin 35% 28%
Profit Margin 12% 6%
Current Ratio 2.0:1 1.3:1
Acid Test 1.2:1 0.6:1
ROCE 18% 9%
TR Days 35 60
TP Days 45 50

Comment on the business's performance.
Step-by-step solution
1. Step 1
  Group ratios by family; comment per family.
Answer
Profitability: GP Margin fell from 35% to 28%, and Profit Margin halved (12% to 6%). This suggests either (a) selling prices fell, or (b) Cost of Sales rose disproportionately. ROCE fell from 18% to 9% — owners are earning much less return.

Liquidity: Current ratio fell from 2.0 to 1.3 — still above 1 but tighter. Acid test fell from 1.2 to 0.6 — concerning, since the business now has only 60p of liquid assets per £1 of current liabilities. Cash flow management is a concern.

Efficiency: TR collection period rose 35→60 days — customers are paying much slower, tying up cash. TP payment period rose 45→50 days — the business is paying suppliers slightly slower, possibly to compensate.

Overall: Performance has deteriorated across all areas. The business is less profitable, less liquid, and less efficient at managing working capital. Management action needed: investigate falling margins, tighten credit control, review inventory.
Examiner tip
A* answers: (1) GROUP by family, (2) link cause and effect (cause-effect chain), (3) suggest CAUSES + ACTIONS. Generic 'numbers got worse' caps at 4/12.
9Recommend whether to extend credit based on ratios
Stretch• Edexcel 4AC1 style — extended (10 marks)• recommendation, AO1, AO2, AO3
Question
A bank is considering a £50,000 loan to a business with the following ratios: Current Ratio 0.8:1; Acid Test 0.4:1; Gearing 65%; Profit Margin 4%; TR Collection Period 75 days; TP Payment Period 30 days. Recommend whether the bank should lend, supporting your decision.
Step-by-step solution
1. Step 1
  Evaluate each ratio against benchmarks and the bank's risk perspective.
Answer
Liquidity (concerning): Current 0.8 and acid test 0.4 — both below 1 — the business cannot pay short-term liabilities from current assets. High liquidity risk.

Gearing (concerning): 65% is HIGH — already heavily reliant on debt. Adding £50,000 more would increase the gearing further.

Profitability (weak): 4% profit margin is thin. Combined with poor liquidity, debt servicing would be a stretch.

Cash flow (poor): customers pay in 75 days but suppliers in 30 days = a cash gap of 45 days. The business is funding suppliers BEFORE collecting from customers — a cash flow drain.

Recommendation: DO NOT LEND without significant additional security or covenants. The business shows poor liquidity, high existing gearing, thin margins and adverse working capital. The risk of default is high.

Counter-balance: if the loan is for a specific revenue-generating asset (machinery, expansion) with a clear payback, the bank might consider lending with conditions (security, monitoring, debt-service ratio covenants).
Examiner tip
Recommend-and-justify questions require: (1) clear position, (2) ratio analysis grouped by area, (3) counter-balance, (4) reasoned conclusion. This pattern earns AO3 marks.

Ratio	2025	2026
GP Margin	35%	28%
Profit Margin	12%	6%
Current Ratio	2.0:1	1.3:1
Acid Test	1.2:1	0.6:1
ROCE	18%	9%
TR Days	35	60
TP Days	45	50

Key Formulae — The calculation and interpretation of accounting ratios

The formulae you need to memorise for the calculation and interpretation of accounting ratios on the Pearson Edexcel IGCSE 4AC1 paper, with every variable defined in plain English and a note on when to use it.

Gross Profit Margin
$GP Margin = (Gross Profit ÷ Sales) × 100$
When to use
Profitability — how much GP per £1 of sales.
Example
60,000 ÷ 200,000 × 100 = 30%.
Mark-up
$Mark-up = (Gross Profit ÷ Cost of Sales) × 100$
When to use
Profitability — markup over cost.
Example
60,000 ÷ 140,000 × 100 = 42.86%.
Profit Margin (Net Profit Ratio)
$Profit Margin = (Profit for the year ÷ Sales) × 100$
When to use
Profitability — bottom-line profit per £ sales.
Example
25,000 ÷ 200,000 × 100 = 12.5%.
Return on Capital Employed (ROCE)
$ROCE = (Profit for the year ÷ Capital Employed) × 100$
$Capital Employed$
Opening Capital + Profit − Drawings + Long-term Liabilities
When to use
Key profitability ratio — return on owner's investment.
Example
25,000 ÷ 125,000 × 100 = 20%.
Current Ratio
$Current Ratio = Current Assets ÷ Current Liabilities$
When to use
Liquidity — can short-term obligations be met? Healthy 1.5–2.0.
Example
26,500 ÷ 14,000 = 1.89 : 1.
Acid Test (Quick) Ratio
$Acid Test = (Current Assets − Inventory) ÷ Current Liabilities$
When to use
Most stringent liquidity test — excludes inventory because it may be slow to sell. Healthy ≥ 1.
Example
(26,500 − 15,000) ÷ 14,000 = 0.82 : 1.
Inventory Turnover (times)
$Inventory Turnover = Cost of Sales ÷ Average Inventory$
$Average Inventory$
(Opening + Closing) ÷ 2
When to use
Efficiency — how many times inventory is sold and replaced.
Example
140,000 ÷ 12,000 = 11.67 times.
Inventory Holding Period (days)
$Inventory Days = (Average Inventory ÷ Cost of Sales) × 365$
When to use
Efficiency — how long inventory is held before sale.
Example
12,000 ÷ 140,000 × 365 = 31.3 days.
Trade Receivables Collection Period
$TR Days = (Trade Receivables ÷ Credit Sales) × 365$
When to use
Efficiency — average time customers take to pay.
Example
25,000 ÷ 180,000 × 365 = 50.7 days.
Trade Payables Payment Period
$TP Days = (Trade Payables ÷ Credit Purchases) × 365$
When to use
Efficiency — average time the business takes to pay suppliers.
Example
18,000 ÷ 150,000 × 365 = 43.8 days.
Gearing Ratio
$Gearing = (Long-term Debt ÷ Capital Employed) × 100$
$Long-term Debt$
Non-current liabilities + Preference shares
When to use
Capital structure — % of capital funded by long-term borrowing.
Example
40,000 ÷ 150,000 × 100 = 26.7%.
Working Capital
$Working Capital = Current Assets − Current Liabilities$
When to use
Liquidity — absolute £ of liquid resources available.
Example
26,500 − 14,000 = £12,500 working capital.

Key Definitions and Keywords — The calculation and interpretation of accounting ratios

Definitions to memorise and the exact keywords mark schemes credit for the calculation and interpretation of accounting ratios answers — sharpened from recent examiner reports for the 2026 Pearson Edexcel IGCSE 4AC1 sitting.

Profitability ratios
Examiner keyword
Ratios that measure how effectively a business generates profit relative to sales, costs or capital — GP Margin, Profit Margin, Mark-up, ROCE.
Liquidity ratios
Examiner keyword
Ratios that measure a business's ability to pay its short-term debts — Current Ratio, Acid Test (Quick) Ratio, Working Capital.
Efficiency / Activity ratios
Examiner keyword
Ratios that measure how effectively the business uses its resources — Inventory Turnover, TR Collection Period, TP Payment Period.
Gearing (Capital Structure)
Examiner keyword
The proportion of total capital funded by long-term borrowing rather than equity. High gearing = more financial risk and more interest cost; low gearing = more financial stability but possibly less leverage for growth.
Capital Employed
Examiner keyword
The total long-term financing of the business: Capital (or Equity) + Non-Current Liabilities. Used in ROCE.
Working Capital
Examiner keyword
Current Assets − Current Liabilities. The day-to-day funds available to run the business.

Common Mistakes and Misconceptions — The calculation and interpretation of accounting ratios

The traps other students keep falling into on the calculation and interpretation of accounting ratios questions — taken from recent Pearson Edexcel IGCSE 4AC1 examiner reports and mark schemes — and how to avoid them.

✕Using Sales instead of Cost of Sales in inventory turnover.
Edexcel 4AC1 examiner reports.
Why it happens
Reflex to use Sales for most ratios.
How to avoid it
Inventory is valued at COST, so inventory turnover MUST use Cost of Sales as numerator. Sales has a profit margin built in.
✕Quoting inventory turnover in DAYS when 'times' is asked (or vice versa).
Why it happens
Forms confusion.
How to avoid it
Times = COGS ÷ Inventory. Days = 365 ÷ Times = Inventory ÷ COGS × 365.
✕Using TOTAL sales instead of CREDIT sales in receivables days.
Why it happens
Students don't separate cash from credit.
How to avoid it
TR Collection Period is about customer credit — use CREDIT sales only (if disclosed). If only total sales are given, use total (with a note).
✕Forgetting to subtract inventory in the Acid Test.
Why it happens
Confusion with Current Ratio.
How to avoid it
Acid Test = (CA − Inventory) ÷ CL. Current Ratio = CA ÷ CL. They differ ONLY in the inventory deduction.
✕Forgetting × 100 when calculating percentages.
Why it happens
Time pressure.
How to avoid it
If the ratio is a %, the formula ends in × 100. Drill this.
✕Calculating ratios but failing to INTERPRET them.
Why it happens
Students treat ratio questions as arithmetic.
How to avoid it
Interpretation = link to a business cause/effect. 'GP margin fell because cost of inputs rose / selling prices fell / inventory write-down occurred.'
✕Saying 'rising current ratio is bad'.
Why it happens
Confusion about preferred direction.
How to avoid it
Liquidity ratios: UP = better (more cushion). Days ratios: UP for receivables/inventory = WORSE (slower). Up for payables can be good (more time to pay) but also signals cash flow strain.

Practice questions

Exam-style questions with step-by-step worked solutions. Try one before checking the method.

Past paper style quiz

Get a report showing which sub-topics you've nailed and which ones still need work.

The calculation and interpretation of accounting ratios

Short Study Notes in the form of Slides

Short Study Notes — The calculation and interpretation of accounting ratios

Detailed Notes

What you’ll learn

How it’s examined

1Classify each ratio by family

2Match each ratio to its formula

3Interpret whether each ratio result is favourable or unfavourable

4Calculate the four profitability ratios

5Calculate the two liquidity ratios

6Calculate the efficiency ratios

7Calculate gearing and interpret

8Interpret a full set of ratios for a business

9Recommend whether to extend credit based on ratios

Gross Profit Margin

Mark-up

Profit Margin (Net Profit Ratio)

Return on Capital Employed (ROCE)

Current Ratio

Acid Test (Quick) Ratio

Inventory Turnover (times)

Inventory Holding Period (days)

Trade Receivables Collection Period

Trade Payables Payment Period

Gearing Ratio

Working Capital

Profitability ratios

Liquidity ratios

Efficiency / Activity ratios

Gearing (Capital Structure)

Capital Employed

Working Capital

✕Using Sales instead of Cost of Sales in inventory turnover.

✕Quoting inventory turnover in DAYS when 'times' is asked (or vice versa).

✕Using TOTAL sales instead of CREDIT sales in receivables days.

✕Forgetting to subtract inventory in the Acid Test.

✕Forgetting × 100 when calculating percentages.

✕Calculating ratios but failing to INTERPRET them.

✕Saying 'rising current ratio is bad'.

Practice questions

Past paper style quiz

Assess your understanding