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Financial Accounting · Analysis of financial statements

How to Interpret Financial Ratios and Write a Report

Updated 11 October 2026 · Fact-checked

Interpreting ratios means explaining what a change or difference in a ratio tells you about performance, liquidity or risk. Compare with a prior year or benchmark, state the movement, give a likely cause using linked ratios, and reach a conclusion. Never just restate the numbers.

Understand Interpreting Ratios and Writing a Report

A ratio on its own means little. A gross margin of 30% could be good or poor. It only gains meaning when you compare it with something: the same business last year, a competitor, an industry average, or a target.

Interpretation has three parts. First, what happened: the ratio went up, down or stayed flat. Second, why it happened: the likely cause, found by linking it to other ratios and to facts in the question. Third, so what: what it means for the business, such as better efficiency, weaker liquidity or higher risk.

Ratios work in groups. Profitability, liquidity, efficiency, gearing and investor ratios each answer a different question. A fall in return on capital employed (ROCE) may come from a lower operating margin, a lower asset turnover, or both. Splitting it shows you where to look.

In FA, Section A tests this with short multiple choice and multiple response items. Section B can ask you to calculate ratios and then comment. Good commentary is short, specific and uses the numbers given. Say what the evidence supports and what it does not. Ratios point to questions; they rarely prove answers.

Key formulas to remember

Gross profit margin
Gross profit ÷ Revenue × 100
Shows profit left after cost of sales. Falls may mean lower selling prices or higher costs.
Operating profit margin
Profit from operations ÷ Revenue × 100
Shows control of overheads as well as cost of sales.
ROCE
Profit before interest and tax ÷ (Total assets − Current liabilities) × 100
Capital employed is equity plus non-current liabilities.
ROCE link
ROCE = Operating margin × Asset turnover
Asset turnover = Revenue ÷ Capital employed. Use it to explain ROCE changes.
Current ratio
Current assets ÷ Current liabilities
Short-term liquidity. Expressed as x : 1.
Quick ratio
(Current assets − Inventory) ÷ Current liabilities
Excludes inventory because it is less quickly turned into cash.
Receivables days
Trade receivables ÷ Credit revenue × 365
Average time customers take to pay.
Payables days
Trade payables ÷ Cost of sales × 365
Average time taken to pay suppliers.
Inventory days
Inventory ÷ Cost of sales × 365
Average time inventory is held.
Gearing
Debt ÷ (Debt + Equity) × 100
Higher gearing means more financial risk. Check which definition the question uses.
Interest cover
Profit before interest and tax ÷ Finance costs
Times profit covers interest.
Commentary rule
Movement + Reason + Implication
Use this in every sentence of commentary.

How to solve Interpreting Ratios and Writing a Report questions

Use this method for any ratio interpretation or report question.

  1. 1Read the requirement. Note who the reader is, such as a lender, investor or manager, and what they care about.
  2. 2Calculate only the ratios asked for, or the key ones in each area. Show the formula and keep the same basis for both years.
  3. 3Decide the comparison: previous year, competitor or benchmark. State the direction and size of each change.
  4. 4Find the cause. Link ratios, for example a lower gross margin alongside higher inventory days. Use facts in the question such as new loans, price cuts or asset purchases.
  5. 5Explain the implication for the reader. Say whether it is good or bad news and why.
  6. 6Note limits or what you would want to know next, such as industry averages or reasons for a one-off item.
  7. 7Finish with a short conclusion that answers the question directly, for example whether the business is better or worse off.

Quickest way: Three-line comment per ratio

When to use it: Use when time is tight, especially in Section B or when a multiple response question asks which statements are supported.

  1. Write the movement with figures: 'Gross margin fell from 30% to 26%.'
  2. Add the most likely cause from the data: 'Cost of sales rose faster than revenue.'
  3. Add the implication: 'Profitability has weakened, so pricing or supplier costs need review.'
  4. In objective tests, test each option against the numbers. Reject any statement that claims a cause the data cannot show.

Common mistakes in Interpreting Ratios and Writing a Report

  • Restating the figures without explaining them

    Calculating feels safer than judging, so students stop at the numbers.

    Fix: Every comment needs a reason and an implication, not just 'the ratio rose from X to Y'.

  • Calling a higher ratio good in every case

    Students learn ratios as 'bigger is better'.

    Fix: Decide by ratio. Higher receivables days and higher gearing are usually bad news. A very high current ratio may mean idle cash or inventory.

  • Mixing bases between years or with benchmarks

    Students use year-end figures in one year and averages in another, or a different capital employed definition.

    Fix: Use the same formula for every period and say which one you used.

  • Treating ratios in isolation

    Each ratio is learned as a separate topic.

    Fix: Link them. Falling ROCE with a stable margin points to asset turnover. Rising payables days with falling current ratio suggests cash pressure.

  • Stating causes as facts

    Students want confident answers.

    Fix: Use words such as 'suggests' or 'may indicate' unless the question gives the cause.

  • Ignoring the user in the question

    Students write general comments.

    Fix: A lender cares about liquidity, gearing and interest cover. An investor cares about profit growth and returns.

Worked examples

Example 1

Company A had revenue of $800,000 and gross profit of $240,000 in Year 1. In Year 2, revenue was $900,000 and gross profit was $225,000. Calculate the gross margin for each year and comment.

Show the solution
  1. Year 1 gross margin = 240,000 ÷ 800,000 × 100 = 30%.
  2. Year 2 gross margin = 225,000 ÷ 900,000 × 100 = 25%.
  3. Movement: margin fell by 5 percentage points.
  4. Cause: revenue rose 12.5% (900,000 ÷ 800,000 = 1.125) but gross profit fell, so cost of sales rose much faster. Cost of sales went from $560,000 to $675,000, an increase of about 20.5%.
  5. Implication: growth was possibly bought with lower selling prices or higher purchase costs, which weakens profitability.

Answer: Gross margin fell from 30% to 25%. Sales grew but cost of sales grew faster, suggesting price cuts or higher input costs. Despite higher revenue, gross profit fell by $15,000.

Example 2

Company B's current liabilities and other data are: Year 1 current assets $300,000 (inventory $120,000), current liabilities $150,000. Year 2 current assets $360,000 (inventory $200,000), current liabilities $240,000. Calculate current and quick ratios and comment for a bank considering a loan.

Show the solution
  1. Year 1 current ratio = 300,000 ÷ 150,000 = 2.0 : 1.
  2. Year 2 current ratio = 360,000 ÷ 240,000 = 1.5 : 1.
  3. Year 1 quick ratio = (300,000 − 120,000) ÷ 150,000 = 1.2 : 1.
  4. Year 2 quick ratio = (360,000 − 200,000) ÷ 240,000 = 0.67 : 1 (160,000 ÷ 240,000).
  5. Cause: inventory rose from $120,000 to $200,000 while current liabilities rose by $90,000, so liquid assets did not keep pace.
  6. Implication for the bank: liquidity has weakened. Quick assets no longer cover current liabilities, so the company relies on selling inventory to pay its debts.

Answer: Current ratio fell from 2.0 to 1.5 and quick ratio from 1.2 to 0.67. Growth in inventory and short-term liabilities has weakened liquidity, so the bank should treat repayment capacity with caution.

Exam tips

  • In objective tests, check each statement against the numbers. Wrong answers often claim a cause that the data cannot prove.
  • For number entry, use the formula and rounding stated in the question, and enter the unit if one is requested.
  • Memorise which direction is good or bad for each ratio, but always consider context.
  • Link two ratios in any comment. Examiners reward the explanation, not the calculation alone.
  • Keep commentary short: one clear point per mark available.

Practice questions from Analysis of financial statements

Interpreting Ratios and Writing a Report in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Interpreting Ratios and Writing a Report: frequently asked questions

How do I comment on a ratio in the ACCA FA exam?

State the movement with figures, give a likely reason from the data, and explain what it means for the business. Keep each comment to a few sentences.

What should I compare ratios with?

Compare with the previous year, a competitor, an industry average or a target. Use whatever the question provides, and make sure the basis is the same.

Is a higher current ratio always better?

No. A higher ratio usually means safer liquidity, but a very high one may mean too much idle cash or slow-moving inventory. Judge it in context.

How do I link ratios together?

Use relationships such as ROCE = operating margin × asset turnover. Also match efficiency ratios to liquidity: longer receivables days can explain a weaker cash position.