ACCA Applied Knowledge · Financial Accounting

Ratios: formula sheet

Full chapter guide

Key formulas

Basic idea of a ratio: Ratio = one figure ÷ a related figure; Express as a percentage, a multiple (times) or a number of days, depending on the ratio.
Valid comparison bases: Trend over time | Other businesses | Industry average | Budget or target; A ratio with no comparison has little meaning. Use like-for-like figures.
Main limitations to remember: Historic data | Different accounting policies | Snapshot date | Inflation | Non-financial factors ignored | Window dressing | Dissimilar businesses; Pick the limitation that fits the scenario given in the question.
Gross profit margin: Gross profit ÷ Revenue × 100; Gross profit = revenue − cost of sales.
Operating profit margin: Operating profit ÷ Revenue × 100; Operating profit is profit before finance costs and income tax.
Return on capital employed (ROCE): Profit before interest and tax ÷ Capital employed × 100; Capital employed = total equity + non-current liabilities. Use the closing figures unless told otherwise.
Mark-up on cost: Gross profit ÷ Cost of sales × 100; Mark-up is based on cost, not selling price.
Margin and mark-up link: Margin = Mark-up ÷ (100% + Mark-up); Mark-up = Margin ÷ (100% − Margin); A 25% mark-up equals a 20% margin.
ROCE split: ROCE = Operating profit margin × Asset turnover; Asset turnover = Revenue ÷ Capital employed. It shows whether a ROCE change comes from margin or from use of capital.
Current ratio: Current ratio = Current assets ÷ Current liabilities; Shown as a ratio, e.g. 1.5 : 1, or as a number of times. Use the closing statement of financial position figures.
Quick ratio (acid test): Quick ratio = (Current assets − Inventory) ÷ Current liabilities; Equals (receivables + cash and bank) ÷ current liabilities when those are the only other current assets.
Reading the result: Ratio above 1 : current assets exceed current liabilities; below 1 : they do not; Treat 2:1 and 1:1 as rough guides only. Always compare with the prior year, the industry and the nature of the business.
Inventory holding period (days): Inventory ÷ Cost of sales × 365; Use closing inventory. Cost of sales is the denominator, not revenue.
Receivables collection period (days): Trade receivables ÷ Credit sales × 365; If credit sales are not given, use revenue and state the assumption.
Payables payment period (days): Trade payables ÷ Credit purchases × 365; If purchases are not given, use cost of sales.
Working capital cycle (days): Inventory days + Receivables days − Payables days; Shorter is generally better for cash.
Net asset turnover (times): Revenue ÷ (Total assets − Current liabilities); Use the definition in the question. Some questions use net assets = total assets − all liabilities.
Non-current asset turnover (times): Revenue ÷ Non-current assets; Shows how well long-term assets generate sales.
Earnings per share (EPS): EPS = (Profit after tax − preference dividends) ÷ Number of ordinary shares in issue; Use the profit attributable to ordinary shareholders. Answer is usually in cents or dollars per share.
Price earnings (PE) ratio: PE = Market price per share ÷ EPS; Answer is a number of years (a multiple), not a percentage.
Dividend per share (DPS): DPS = Ordinary dividends ÷ Number of ordinary shares in issue; Use ordinary dividends only, not preference dividends.
Dividend yield: Dividend yield = (DPS ÷ Market price per share) × 100%; Uses market price, not nominal value.
Dividend cover: Dividend cover = EPS ÷ DPS (or profit for ordinary shareholders ÷ ordinary dividends); Answer is in times, such as 2.5 times.
Earnings yield (related): Earnings yield = (EPS ÷ Market price) × 100%; The inverse of the PE ratio, shown as a percentage.
Gearing (debt to equity): Gearing = Debt ÷ Equity × 100%; Debt means long-term borrowings, including loan notes and preference shares treated as debt. Equity means share capital plus all reserves.
Gearing (debt to capital employed): Gearing = Debt ÷ (Debt + Equity) × 100%; Debt + equity is capital employed in this version. Same company, different answer from debt ÷ equity. Use the version the question asks for.
Interest cover: Interest cover = Profit before interest and tax ÷ Finance costs; Answer is in times, such as 4.0 times. Use profit from operations before finance costs and tax.
Capital employed: Capital employed = Equity + Non-current liabilities; Useful check on the denominator. Include only interest-bearing debt in the debt figure.
Gross profit margin: Gross profit ÷ Revenue × 100; Shows profit after cost of sales. Falls if prices drop or direct costs rise.
Operating profit margin: Profit before interest and tax (PBIT) ÷ Revenue × 100; In this page, operating margin means PBIT ÷ revenue. Compare with gross margin to spot changes in overheads.
Return on capital employed (ROCE): Profit before interest and tax ÷ (Total assets − Current liabilities) × 100; Capital employed is equity plus non-current liabilities. Also equals PBIT margin × asset turnover, provided you use the same capital employed figure in both ROCE and asset turnover.
Asset turnover: Revenue ÷ Capital employed; Shows how hard assets are worked. ROCE = operating margin (PBIT ÷ revenue) × asset turnover, but only when the same capital employed figure is used in both.
Current ratio: Current assets ÷ Current liabilities; Short-term liquidity. No single ideal figure; depends on the industry.
Quick (acid test) ratio: (Current assets − Inventory) ÷ Current liabilities; Removes inventory as it is the least liquid current asset.
Inventory days: Inventory ÷ Cost of sales × 365; Use year-end inventory unless told to use an average.
Receivables days: Trade receivables ÷ Credit revenue × 365; Use revenue if credit sales are not given.
Payables days: Trade payables ÷ Cost of sales × 365; Use purchases if given.
Gearing: Debt ÷ Equity × 100, or Debt ÷ (Debt + Equity) × 100; State which version you use. Follow the question's definition.
Interest cover: Profit before interest and tax ÷ Finance costs; Shows how easily profit covers interest.
Commentary pattern: Movement → Amount → Reason → Meaning; Use for every point you make.

Quick revision

Ratios are only useful when compared with prior years, other businesses or industry averages.
Gross profit margin = gross profit ÷ revenue × 100.
Operating profit margin = profit from operations ÷ revenue × 100.
Current ratio = current assets ÷ current liabilities; quick ratio = (current assets − inventory) ÷ current liabilities.
Inventory days = inventory ÷ cost of sales × 365; receivables days = trade receivables ÷ credit sales × 365; payables days = trade payables ÷ credit purchases × 365.
Working capital cycle = inventory days + receivables days − payables days.
Earnings per share = profit attributable to ordinary shareholders ÷ number of ordinary shares; P/E = market price per share ÷ EPS.
Gearing is commonly debt ÷ equity or debt ÷ (debt + equity); use the definition the question gives.
Interest cover = profit before interest and tax ÷ finance costs.
Return on capital employed = profit before interest and tax ÷ (total assets − current liabilities) × 100.
Always check the unit, the rounding and whether the question asks for a percentage, times or days.
In a comment, state the change, give a likely reason and say what it means for the business.

Common mistakes

Saying ratios predict future performance. Fix: Remember that ratios use historic data. They may help you judge the future but they do not forecast it.
Stating a ratio changed without giving a reason. Fix: After every figure, add why. Link to scenario clues, for example a loan, a price cut or higher costs.
Using profit after interest and tax in ROCE. Fix: Use operating profit, which is profit before finance costs and income tax.
Dividing by cost of sales when asked for gross margin. Fix: Margin always divides by revenue. Mark-up divides by cost of sales.
Leaving out the bank overdraft from current liabilities. Fix: An overdraft is a liability repayable on demand. Include it in current liabilities.
Deducting receivables or cash instead of inventory in the quick ratio. Fix: Only inventory is removed. Receivables and cash stay in.
Using revenue instead of cost of sales for inventory days. Fix: Inventory is held at cost, so compare it with cost of sales. Say this to yourself every time.
Adding payables days in the working capital cycle. Fix: Payables days are credit from suppliers, so they reduce the cycle. Subtract them.
Forgetting to deduct preference dividends before calculating EPS Fix: Always ask: are there preference shares? If so, deduct their dividend first.
Using nominal value instead of market price in PE or yield Fix: PE and dividend yield always use the current market price per share.

Exam tips

In objective questions, eliminate any option that says ratios give a complete or forward-looking picture.
For multiple response, select exactly the number asked and choose distinct limitations.
When comparing two businesses, check accounting policies first, then size and industry.
In scenario questions, tie every comment to a clue given, not a generic point.
Pair limitations with purpose: ratios help assess performance and position, but need a comparison base.
Check which profit figure the question gives. Operating profit and profit before interest and tax are the same for ROCE in most FA questions.
In multiple response questions on reasons, pick only the causes that fit both the ratio and the figures given.
Practise margin and mark-up conversions. They appear often in objective tests, including incomplete records questions.