BA3: Analysis

Answer: C. Current ratio = current assets ÷ current liabilities = £60,000 ÷ £30,000 = 2, usually expressed as 2:1. It measures short-term liquidity — the ability to meet current liabilities from current assets. A ratio of 2:1 means the company has twice as many current assets as current liabilities. The 0.5:1 figure inverts the calculation, dividing liabilities by assets.

Answer: D. Gross profit margin = gross profit ÷ sales × 100 = £45,000 ÷ £100,000 × 100 = 45%. It shows the proportion of each pound of sales remaining after the cost of sales, indicating profitability and pricing strength. The 55% figure would be the cost of sales as a percentage of sales (the complement of the margin). The margin is always expressed relative to sales revenue. 2.2% and 222% both invert the ratio (sales ÷ gross profit), with or without multiplying by 100.

Answer: A. A current ratio well above the norm can signal that the company is tying up too much in inventory, receivables or idle cash rather than using those resources productively — liquidity can be excessive as well as insufficient. A very high ratio does not point to imminent insolvency (a very low ratio might), nor to an excess of current liabilities or an absence of current assets. Ratios must be interpreted in context rather than judged on a 'higher is always better' basis.

Answer: D. Receivables collection period = (trade receivables ÷ credit sales) × 365 = (£20,000 ÷ £146,000) × 365 = 50 days. This measures the average time customers take to pay. A longer period may signal poor credit control or cash flow problems. The figure is calculated relative to credit sales, and multiplying the ratio by 365 converts it into days. 40 days and 73 days do not follow from the figures, and 20 days ignores the conversion into days.

Answer: A. Gearing measured as debt ÷ (debt + equity) = £200,000 ÷ (£200,000 + £300,000) = £200,000 ÷ £500,000 = 40%. This shows the proportion of the company's long-term capital that is financed by debt. The 66.7% figure is the alternative debt-to-equity measure (£200,000 ÷ £300,000), and 150% inverts it. Higher gearing means greater reliance on borrowing and higher financial risk. 60% is the equity proportion (£300,000 ÷ £500,000), not the debt proportion.

Answer: D. The quick ratio excludes inventory from current assets, as inventory is the least liquid current asset: (£80,000 − £30,000) ÷ £25,000 = £50,000 ÷ £25,000 = 2, or 2:1. The 3.2:1 figure is the ordinary current ratio (£80,000 ÷ £25,000), which includes inventory. The quick ratio gives a stricter test of whether short-term obligations can be met from the most liquid assets.

Answer: B. Inventory holding period = (inventory ÷ cost of sales) × 365 = (£10,000 ÷ £73,000) × 365 = 50 days. This measures how long, on average, inventory is held before being sold. It is calculated against cost of sales (not revenue), because inventory is held at cost. A longer holding period ties up more cash in inventory and may indicate slow-moving stock. 73, 37 and 146 days do not follow from the inventory and cost of sales figures.

Answer: C. Ratio analysis draws on historical financial statements, so the ratios may not reflect current or future conditions, and differing accounting policies between companies can make comparisons misleading. Ratios can be calculated for businesses of any size, they require interpretation and judgement rather than removing it, and they rarely give a single definitive answer. Recognising these limitations is essential to using ratios sensibly.

Answer: D. ROCE = operating profit ÷ capital employed × 100 = £120,000 ÷ £800,000 × 100 = 15%. ROCE measures how efficiently the business uses its long-term capital to generate operating profit and is a key measure of overall profitability. The 6.7% figure inverts the ratio. Capital employed is usually total equity plus long-term debt, representing the funds invested in the business. 18% and 12% do not follow from the profit and capital figures.

Answer: A. Net profit margin = net profit ÷ revenue × 100 = £30,000 ÷ £200,000 × 100 = 15%. It shows the proportion of each pound of sales that becomes net profit after all operating costs, indicating overall cost control and profitability. The 6.7% figure inverts the ratio. The margin is always expressed relative to revenue, allowing comparison of profitability across periods and businesses of different sizes. 30% reads the £30,000 profit as a percentage, and 20% does not follow from the figures.

Answer: A. Interest cover = operating profit ÷ finance costs = £90,000 ÷ £15,000 = 6 times. It measures how many times the profit could pay the interest charge, indicating the safety margin for debt servicing. A higher figure means lower risk of being unable to meet interest payments. The 0.17 figure inverts the ratio. Lenders watch interest cover closely as a sign of financial risk. 75 times is the difference between the two figures, not a ratio, and 1.2 times divides operating profit by profit after interest (£90,000 ÷ £75,000).

Answer: B. Asset turnover = revenue ÷ capital employed = £600,000 ÷ £400,000 = 1.5 times. It measures how efficiently the business uses its capital to generate sales — each £1 of capital employed produced £1.50 of revenue. The 0.67 figure inverts the ratio. Asset turnover and net profit margin together drive return on capital employed, since ROCE = margin × asset turnover. 15 times misplaces the decimal point, and 2.4 times does not follow from the figures.

Answer: A. Operating profit margin = operating profit ÷ revenue × 100 = £40,000 ÷ £200,000 × 100 = 20%. It shows the proportion of revenue remaining as operating profit after cost of sales and operating expenses but before finance costs and tax. The 5% figure inverts the ratio. Comparing the operating margin over time or against competitors helps assess how well the business controls its operating costs. 40% reads the £40,000 profit as a percentage, and 80% is the proportion of revenue absorbed by costs.

Answer: B. Payables payment period = (trade payables ÷ credit purchases) × 365 = (£12,000 ÷ £73,000) × 365 = 60 days. It measures the average time the business takes to pay its suppliers. Taking longer to pay can ease cash flow but may strain supplier relationships or forfeit discounts. The period is calculated against credit purchases, and multiplying by 365 converts the ratio into days. 50, 73 and 30 days do not follow from the figures; with purchases of £73,000, each £200 of payables represents one day.

Answer: D. A current ratio below 1:1 means current liabilities exceed current assets, suggesting the business may struggle to meet its short-term obligations as they fall due — a liquidity concern. The ratio is about short-term solvency, not about selling non-current assets, raising long-term finance, or distant future dividends. A persistently low current ratio can be an early warning sign of cash flow difficulties, though it must be judged in context.