ACCA Applied Skills · Financial Reporting

Calculation and interpretation of accounting ratios and trends to address users' and stakeholders' needs: formula sheet

Full chapter guide

Key formulas

Return on capital employed (ROCE): ROCE = profit before interest and tax ÷ (total assets − current liabilities) × 100; Used by investors and lenders to judge overall efficiency of capital use.
Current ratio: Current ratio = current assets ÷ current liabilities; Used by suppliers and short-term lenders to judge ability to pay debts due within a year.
Gearing: Gearing = debt ÷ equity × 100 (or debt ÷ (debt + equity) × 100); Used by lenders and shareholders to judge financial risk. State which version you use.
Interest cover: Interest cover = profit before interest and tax ÷ finance costs; Used by lenders to judge whether interest is safely covered by profit.
Earnings per share: EPS = profit attributable to ordinary shareholders ÷ weighted average number of ordinary shares; Used by investors to assess return per share.
Dividend cover: Dividend cover = profit for the year available to ordinary shareholders ÷ ordinary dividends; Used by investors to judge how sustainable dividends are.
Return on capital employed (ROCE): ROCE = Profit before interest and tax ÷ (Total assets − Current liabilities) × 100%; Capital employed equals equity plus non-current liabilities. Use the same definition every year and state it.
Gross profit margin: Gross profit ÷ Revenue × 100%; Shows the effect of selling prices and cost of sales.
Operating profit margin: Profit from operations (before finance costs and tax) ÷ Revenue × 100%; Compare with gross margin to see whether overheads are under control.
Net profit margin: Profit after tax ÷ Revenue × 100%; Affected by finance costs and tax as well as operations. Some questions use profit before tax, so state your choice.
Asset turnover: Revenue ÷ Capital employed (times); Same capital employed figure as in ROCE. Some questions use total assets or net assets, so state it.
ROCE link: ROCE = Operating profit margin × Asset turnover; Works exactly only if the same profit and capital employed figures are used throughout.
Return on equity (ROE): Profit after tax ÷ Total equity × 100%; Profit attributable to owners of the parent over equity attributable to them is used in group questions.
Current ratio: Current assets ÷ Current liabilities; Shown as a ratio, such as 1.5 : 1. Includes inventory.
Quick ratio: (Current assets − Inventory) ÷ Current liabilities; Also called the acid test ratio.
Inventory days: (Inventory ÷ Cost of sales) × 365; Use average inventory only if the question asks for it or gives opening figures.
Receivables days: (Trade receivables ÷ Credit revenue) × 365; Use total revenue if credit sales are not given, and state this.
Payables days: (Trade payables ÷ Credit purchases) × 365; If purchases are not given, use cost of sales and state this.
Cash operating cycle: Inventory days + Receivables days − Payables days; Measured in days. A shorter cycle usually means less cash is tied up.
Gearing (debt ÷ equity): Gearing = Long-term debt ÷ Equity × 100%; Equity means share capital plus all reserves. Include preference shares and long-term borrowings as debt unless told otherwise.
Gearing (debt ÷ capital employed): Gearing = Long-term debt ÷ (Debt + Equity) × 100%; Use the definition the question gives. If none is given, state the one you use and keep it consistent.
Interest cover: Interest cover = Profit before interest and tax ÷ Finance costs; Answer is in times. Use profit from operations before finance costs.
Earnings per share: EPS = (Profit after tax − preference dividends) ÷ Weighted average ordinary shares; Earnings are those attributable to ordinary shareholders.
Price/earnings ratio: P/E = Market price per share ÷ EPS; Answer is in times (years of earnings).
Dividend cover: Dividend cover = Profit for ordinary shareholders ÷ Ordinary dividends; Equivalent to EPS ÷ dividend per share. Answer in times.
Dividend yield: Dividend yield = Dividend per share ÷ Market price per share × 100%; Use the dividend per share for the same period as the price.
Percentage change (horizontal analysis): Change % = (Current year − Prior year) ÷ Prior year × 100; Always divide by the earlier year (the base). A negative result is a fall.
Trend index: Index = Year figure ÷ Base year figure × 100; Base year is set at 100. An index of 125 means 25% above the base year.
Common-size statement of profit or loss: Line item % = Line item ÷ Revenue × 100; Revenue is 100%. Gross and operating margins appear as the subtotals.
Common-size statement of financial position: Line item % = Line item ÷ Total assets × 100; Total assets equals total equity and liabilities, so both sides add to 100%.
Percentage point change: Point change = Current % − Prior %; Use this for changes in common-size percentages. Do not call a move from 40% to 45% a 5% rise.
Group profit margin: Group profit from operations ÷ Group revenue × 100; Associate profit is usually below operating profit, so exclude it for an operating margin.
ROCE (group): Profit before interest and tax ÷ (Total equity including NCI + Non-current debt) × 100; Total equity includes NCI because the capital employed is all consolidated.
Return on parent's equity: Profit attributable to owners of the parent ÷ Equity attributable to owners × 100; Both figures exclude NCI.
NCI share of profit: Profit after tax of subsidiary × NCI % (adjusted for group adjustments); Check the statement of profit or loss for the split.
EPS: Profit attributable to owners of the parent ÷ Weighted average ordinary shares; Never use total profit.
Segment margin: Segment profit ÷ Segment revenue × 100; Use the segment profit measure disclosed.
Return on segment assets: Segment profit ÷ Segment assets × 100; Use the same profit and asset definitions for every segment.
Segment share of group: Segment revenue (or profit) ÷ Group total × 100; Shows dependence on a segment.

Quick revision

Name the user first, then choose the ratios that answer their question.
Gross profit margin = gross profit ÷ revenue × 100.
Operating profit margin = profit from operations ÷ revenue × 100.
Return on capital employed = profit before interest and tax ÷ (total assets − current liabilities) × 100.
Current ratio = current assets ÷ current liabilities; quick ratio excludes inventory.
Inventory days = inventory ÷ cost of sales × 365; receivables days = receivables ÷ revenue × 365.
Payables days = payables ÷ cost of sales × 365, using purchases only if you are given them.
Gearing can be debt ÷ equity or debt ÷ (debt + equity); state which one you use.
Interest cover = profit before interest and tax ÷ finance costs.
Earnings per share and price/earnings ratio link profit to the market price.
In common-size analysis, express each item as a percentage of a base such as revenue or total assets.
Always compare with a prior year, a competitor or an industry figure, and mention the limits of the comparison.

Common mistakes

Listing users without explaining what each needs. Fix: Link every user to a specific question and to information in the statements that answers it.
Treating managers as external users. Fix: Managers are internal and can obtain management information directly. Published statements mainly serve external users.
Using profit after interest in ROCE. Fix: ROCE uses profit before interest and tax, because capital employed includes debt. Add back finance costs to profit before tax.
Using only equity as capital employed. Fix: Capital employed is total assets less current liabilities, which equals equity plus non-current liabilities.
Using total revenue for receivables days when credit sales are given. Fix: Check the question for credit sales. If none is given, use revenue and say so.
Using revenue instead of cost of sales for inventory days or payables days. Fix: Inventory is held at cost, so use cost of sales. Payables relate to purchases or cost of sales.
Using profit after interest for interest cover Fix: Add finance costs back to get PBIT, or use profit from operations. Then divide by finance costs.
Leaving out reserves from equity in gearing Fix: Equity is share capital plus share premium plus all reserves including retained earnings.
Dividing the change by the current year instead of the prior year. Fix: Always use the earlier year as the base. Write the formula at the top of your working.
Describing a change in a common-size percentage as a percentage change. Fix: Say percentage points for differences between two common-size percentages.

Exam tips

Always name the user in your answer and write from their viewpoint. Generic commentary scores poorly.
In Section C, structure answers by user, then ratio, then conclusion. Use short headed paragraphs.
In objective questions, check whether the user is internal or external and whether the ratio matches the need before choosing.
Give a comparison for every ratio: prior year, industry or target. A number alone earns little.
Mention limitations briefly. One sentence on historical data or comparability is usually enough.
Write your definition of capital employed and profit in one line before calculating. Markers give credit for clear, consistent definitions.
In Section C, spend more time on explanation than arithmetic. Each point needs a change, a cause and a consequence.
Use the ROCE = margin × asset turnover link to structure your answer, and say which factor drove the change.