Interpreting company accounting information: formula sheet

Key formulas

Two main purposes

Decision usefulness + Stewardship

Accounts help users decide, and show how directors used owners' resources.

Core statements

Financial position + Profit or loss + Cash flows (+ changes in equity and notes)

Name the statement that answers each user's question.

Accounting equation

Assets = Liabilities + Equity

Underlies the statement of financial position.

Cash versus profit

Profit ≠ cash generated

Profit is on an accruals basis; cash flow shows actual receipts and payments.

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 interest and tax (PBIT), unless the question defines it otherwise.

Net profit margin

Profit after tax ÷ Revenue × 100%

Some questions use profit before tax. State which you use.

Return on capital employed (ROCE)

Profit before interest and tax ÷ Capital employed × 100%

Capital employed = Total assets − Current liabilities = Equity + Non-current liabilities.

Return on equity (ROE)

(Profit after tax − Preference dividends) ÷ Ordinary shareholders' equity × 100%

Equity is often taken at year end. Average equity is also acceptable if you state it.

ROCE breakdown

ROCE = Operating margin × (Revenue ÷ Capital employed)

Use it to explain whether margin or asset use caused a change.

Current ratio

Current ratio = Current assets ÷ Current liabilities

Shown as a ratio, e.g. 1.5 : 1, or as a number of times.

Quick ratio

Quick ratio = (Current assets - Stock) ÷ Current liabilities

Also called the acid test. Some questions also exclude prepayments; follow the question's definition.

Stock days

Stock days = (Closing stock ÷ Cost of sales) × 365

Use cost of sales, not revenue. Some questions use average stock.

Debtor days

Debtor days = (Trade receivables ÷ Credit sales) × 365

Use revenue if credit sales are not given, and say so.

Creditor days

Creditor days = (Trade payables ÷ Credit purchases) × 365

If purchases are not given, use cost of sales and state the assumption.

Working capital cycle

Cycle = Stock days + Debtor days - Creditor days

Measured in days. It is the time cash is tied up in operations.

Asset turnover

Asset turnover = Revenue ÷ Total assets (or capital employed)

State which asset base you used and use it consistently.

Gearing ratio (debt to capital employed)

Gearing = Debt ÷ (Debt + Equity) × 100%

Debt is usually long-term borrowings, sometimes with preference shares. Equity is share capital plus reserves. State your definition.

Gearing ratio (debt to equity version)

Gearing = Debt ÷ Equity × 100%

This is the same as the debt-to-equity ratio. Some books use the term gearing for this form.

Debt-to-equity ratio

Debt-to-equity = Debt ÷ Equity

Can be shown as a percentage or as a ratio such as 0.5 : 1.

Interest cover

Interest cover = Profit before interest and tax (PBIT) ÷ Interest expense

Shown in times. Use finance costs from the profit and loss account. Higher means safer.

Converting between the two gearing forms

Debt ÷ (Debt + Equity) = (D/E) ÷ (1 + D/E)

For example, D/E of 0.5 gives 0.5 ÷ 1.5 = 33.3%.

Earnings per share (EPS)

EPS = (Profit after tax and preference dividends) ÷ (Number of ordinary shares)

Use the weighted average number of shares if shares were issued during the year. Take out preference dividends and minority interests first.

Price-earnings ratio

P/E = Market price per share ÷ EPS

Answer is in 'times' or years of earnings. Compare with sector or past values.

Earnings yield

Earnings yield = EPS ÷ Market price per share = 1 ÷ P/E

Often shown as a percentage.

Dividend per share

DPS = Ordinary dividends ÷ Number of ordinary shares

Use the dividend for the same year as the EPS.

Dividend yield

Dividend yield = DPS ÷ Market price per share × 100%

Gross of any tax paid by the investor.

Dividend cover

Dividend cover = EPS ÷ DPS = Earnings for ordinary shareholders ÷ Ordinary dividends

Expressed in times. Below 1 means dividends exceed earnings.

Payout ratio

Payout ratio = DPS ÷ EPS = 1 ÷ Dividend cover

Percentage of earnings paid out.

Net asset value per share

NAV per share = Net assets attributable to ordinary shareholders ÷ Number of ordinary shares

Compare with market price to judge market value against book value.

Net change in cash

Net change in cash = Operating CF + Investing CF + Financing CF

Closing cash = opening cash + net change. Cash includes cash equivalents.

Operating cash flow (indirect method)

Operating CF = Profit before tax + Depreciation (and other non-cash charges) + Finance costs (if shown under financing) − Investment income (if shown under investing) − Increase in inventory − Increase in receivables + Increase in payables − Tax paid

Reverse the sign for decreases in working capital items. Keep interest and tax treatment consistent with the statement presented.

Free cash flow (common simple form)

Free cash flow = Operating CF − Capital expenditure

Definitions vary. State which one you use. Some versions also deduct interest paid or tax.

Cash conversion of profit

Cash conversion = Operating CF ÷ Profit after tax

A ratio near or above 1 suggests profit is backed by cash. Judge it over several years, not one.

Cash interest cover

Cash interest cover = Operating CF before interest and tax ÷ Interest paid

Shows ability to service debt from cash rather than from profit.

Capex coverage

Capex coverage = Operating CF ÷ Capital expenditure

A value above 1 means operations fund investment without outside finance.

Ratio as a comparison

Ratio = Figure A ÷ Figure B

Only meaningful if A and B are measured consistently and compared with a suitable benchmark.

Current ratio

Current ratio = Current assets ÷ Current liabilities

Year-end actions such as paying creditors early or delaying payments can change it, which is why it is a common example of window dressing.

Return on capital employed

ROCE = Profit before interest and tax ÷ Capital employed

Affected by historical cost, depreciation policy and inflation.

Percentage change for trends

Change % = (This year − Last year) ÷ Last year × 100

Use to compare movements over time, not just single-year levels.

Quick revision

• Users of accounts include investors, lenders, employees, suppliers, customers, managers and regulators, and each wants different information.
• Gross margin = gross profit ÷ revenue; operating margin = operating profit ÷ revenue.
• Return on capital employed compares operating profit with the capital used; use the definition given in your study material.
• Asset turnover = revenue ÷ assets used, and it shows how well assets generate sales.
• Current ratio = current assets ÷ current liabilities; the quick ratio leaves out inventory.
• Inventory, receivables and payables days show how long working capital is tied up.
• Gearing compares debt with equity or total capital; higher gearing means higher financial risk.
• Interest cover = operating profit ÷ interest, and it shows how safely interest is paid.
• Earnings per share = profit attributable to ordinary shareholders ÷ number of ordinary shares.
• Price earnings ratio = share price ÷ earnings per share.
• Dividend cover = earnings ÷ dividends, and it shows how easily a dividend is paid.
• Profit is not cash; check the cash flow statement for cash from operations, investing and financing.
• Ratios depend on accounting policies, timing, size and industry, so compare like with like.

Common mistakes

• Listing users with no needs attached Fix: Always add the decision each user makes and the information they look at.
• Saying accounts show the true current value of the company Fix: State that many assets are at historical cost or estimates and that market value can differ.
• Using profit after interest in ROCE Fix: ROCE uses profit before interest and tax, as capital employed includes debt.
• Leaving out non-current liabilities from capital employed Fix: Add long-term debt to equity, or subtract current liabilities from total assets.
• Using revenue instead of cost of sales for stock days and creditor days. Fix: Stock and creditors are valued at cost, so match them with cost of sales or purchases. Only debtors match revenue.
• Forgetting to remove stock in the quick ratio. Fix: Write (CA - Stock) explicitly before dividing.
• Mixing up gearing as debt ÷ (debt + equity) with debt ÷ equity. Fix: Read the definition in the question. If none is given, state which form you use. Check that D ÷ E is always larger than D ÷ (D + E).
• Using profit after interest or after tax in interest cover. Fix: Use profit before interest and tax in the numerator. Interest must not already be deducted.
• Forgetting to deduct preference dividends from profit when calculating EPS. Fix: Always write 'earnings for ordinary shareholders' as a separate line: profit after tax less preference dividends (and minority interests if any).
• Using total dividends instead of dividend per share, or dividing by the wrong share count. Fix: Convert everything to per-share or everything to totals before dividing. Check that numerator and denominator are in the same units.

Exam tips

• Always tie each user to a decision. Marks are usually for the link, not for naming the user.
• For limitations, give at least three distinct points: historical basis, estimates and judgement, and omitted non-financial factors.
• In multiple-choice questions, watch for absolute words like always, guarantees or true value. They are usually wrong.
• If a question names one user, answer only for that user. Extra users waste time.
• Use the case details in the question, such as falling cash or high borrowing, to make your answer specific.
• Write the formula before the numbers. Method marks are given even if the arithmetic slips.
• State your definition of profit and capital employed when the question leaves it open.
• Comparison questions need both calculation and reasons. Aim for one explanatory sentence per ratio.