Analysis and interpretation

• Three groups, ten formulas, one habit: calculate, compare, explain, advise, qualify. Never stop at the number.
• Before you write any ratio down, ask three questions: Is this the syllabus formula? Are these the right inputs? Is the answer in the right form? Then, and only then, ask what it means.
• Four inputs, four separate lines of working, before any ratio is attempted: average inventory, credit purchases, profit before interest, capital employed.
• Liquidity ratios ask can the business pay? Efficiency ratios ask how long is the cash trapped? A business with good liquidity ratios and slow efficiency ratios is holding its cover in forms that are slow to become money.
• If you have five minutes and nothing else, write the ten formulas and the form each answer takes. Everything else in topic 6 is built on getting those right.

• 6.1 — I can state all ten syllabus ratio formulas exactly as printed, and I use no other version.
• 6.1 — I present each result in its required form: percentages for profitability, x : 1 for liquidity, times or days for efficiency.
• 6.1 — I can build the four inputs that are rarely given: average inventory, credit purchases, profit before interest and capital employed.
• 6.1 — I can state capital employed for a limited company and for a sole trader or partnership.
• 6.1 — I state the assumption in writing whenever the credit split of sales or purchases is not given.
• 6.2 — I can prepare a comparison statement of two years and comment on the direction, likely cause and consequence of each change.
• 6.2 — I can explain what changes gross profit, and why expenses are not on that list.
• 6.2 — I can explain what changes profit for the year, separating it from what changed gross profit.
• 6.2 — I can interpret each liquidity and efficiency ratio without claiming a universal ideal figure.
• 6.2 — I can suggest actions to improve profitability, liquidity and working capital, naming the ratio improved, the side effect and the condition.
• 6.2 — I can give six reasons why cash and profit differ, and explain overtrading in one sentence.
• 6.3 — I can explain the factors that make two businesses' ratios differ and the problems of inter-business comparison.
• 6.4 — I can name all ten groups of interested parties, the decision each makes and the information each uses.
• 6.5 — I can explain historic cost, the application of accounting policies and non-financial aspects as limitations, each with an example.

Why the assessment objectives matter here. Across the qualification, knowledge and understanding is 66 % of the marks, analysis 24 % and evaluation 10 %. Analysis is assessed on both papers — 20 % of Paper 1 and 25 % of Paper 2 — while evaluation is assessed only on Paper 2. Those are the syllabus's own figures. This is a topic where both objectives arise naturally: calculating a ratio is knowledge and analysis, and judging what a change means and what should be done about it is evaluation.

• “Any sensible formula for a ratio is acceptable.” Correction Only the ten formulas printed in the syllabus are accepted. ROCE uses profit for the year before interest over capital employed of issued shares \(+\) reserves \(+\) non-current liabilities. The syllabus accepts no other, however good the arithmetic.
• “The current ratio should always be 2 : 1.” Correction There is no universal ideal. It depends on the type of business and on how quickly inventory and trade receivables turn into cash. Judge it against last year, against the trade and against the owner's objective.
• “A higher current ratio is always better.” Correction Excessive current assets mean idle cash earning nothing, surplus inventory at risk of obsolescence, or customers who are not paying. Check the acid test ratio and the turnover ratios before calling a rise an improvement.
• “Profit margin uses gross profit.” Correction Profit margin uses profit for the year over revenue. Gross profit margin uses gross profit over revenue; mark-up uses gross profit over cost of sales. Three ratios, three different pairs.
• “Trade receivables days uses total revenue.” Correction It uses credit sales, and trade payables days uses credit purchases. Where the split is not given, use the total and state the assumption in writing.
• “A falling gross profit margin means expenses rose.” Correction Expenses are deducted after gross profit and cannot affect it. Look at selling prices, purchase prices, the sales mix and the valuation of inventory.
• “Profit and cash move together.” Correction Credit trading, capital expenditure, depreciation, drawings, loans, capital introduced, accruals and unsold inventory all separate them. A profitable business can run out of money, and a business making a loss can see its bank balance rise.
• “Two businesses with the same ROCE are equally successful.” Correction Accounting policies, size, age, financing, year ends and non-financial factors can make identical ratios mean quite different things. Say which of those conditions is unmet before concluding anything.
• “Accounting statements show what a business is worth.” Correction Historic cost, the choice of accounting policies and the omission of non-financial factors mean they do not. They show what was paid, on one chosen basis, for the things that can be measured in money.
• “The ratio is the answer.” Correction A ratio with no comparison is a calculation. What 6.2 asks for is the direction, the likely cause, the consequence, a recommendation and the condition that recommendation depends on.

• Evaluation is examined only on Paper 2, and topic 6 is where it naturally lives: the material gives you two years of figures and asks what changed, why, what should be done and what doing it would cost.
• A ratio question here may be a short calculation from three or four given figures, or a one-step interpretation (“which change would increase the acid test ratio?”).
• Treat every option as a possible method error — the wrong formula, the wrong input, or the right number in the wrong form. The twelve questions in this chapter are built that way, so read all four options before choosing.
• Check the form of the answer as well as its size: an option in days when the question asks for times is wrong, however the arithmetic went.
• A ratio question can chain several command words across its parts: calculate three or four ratios → compare with the previous year or another business → explain a change → suggest or advise → evaluate.
• Calculate means work out from the given figures. Set out the formula, then the figures substituted into it, then the answer with its unit — that keeps the choice of method visible and separate from the arithmetic, so a slip in one does not hide the other.