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9706 · 1.6.2

Calculation and evaluation of ratios — practice questions

Practice and worked examples for 9706 Calculation and evaluation of ratios. Short previews only — attempt the full question in MarkScheme against the official scheme.

Worked example 1

Revenue $500,000; gross profit $150,000; net profit $40,000; PBIT $55,000; capital employed $400,000; current assets $90,000 (inventory $30,000); current liabilities $60,000. Calculate GP margin, ROCE, current ratio, and acid test.

Show solution outline

GP margin = ($150,000 ÷ $500,000) × 100 = 30%

ROCE = ($55,000 ÷ $400,000) × 100 = 13.75%

Current ratio = $90,000 ÷ $60,000 = 1.5 : 1

Acid test = ($90,000 − $30,000) ÷ $60,000 = 1.0 : 1

Interpretation: Healthy GP margin; ROCE acceptable if cost of capital is lower; liquidity is adequate but the acid test is at the minimum benchmark, suggesting a reliance on selling inventory to meet short-term debts.

Worked example 2

Company Z provides the following financial data for two years. All revenue is on credit.

ItemYear 1 ($)Year 2 ($)
Revenue800,000950,000
---------
Cost of Sales480,000600,000
Average Inventory60,00085,000
Trade Receivables80,000110,000
Non-Current Liabilities200,000280,000
Capital Employed500,000600,000

Calculate the inventory turnover (days), trade receivables turnover (days), and gearing ratio for both years and briefly comment on the trends.

Show solution outline

1. Inventory Turnover (days) = (Average Inventory / Cost of Sales) × 365

  • Year 1: ($60,000 / $480,000) × 365 = 45.6 days (rounded to 46 days)
  • Year 2: ($85,000 / $600,000) × 365 = 51.7 days (rounded to 52 days)

2. Trade Receivables Turnover (days) = (Trade Receivables / Credit Revenue) × 365

  • Year 1: ($80,000 / $800,000) × 365 = 36.5 days (rounded to 37 days)
  • Year 2: ($110,000 / $950,000) × 365 = 42.2 days (rounded to 42 days)

3. Gearing Ratio = (Non-Current Liabilities / Capital Employed) × 100

  • Year 1: ($200,000 / $500,000) × 100 = 40%
  • Year 2: ($280,000 / $600,000) × 100 = 46.7%

Interpretation: The company's efficiency has worsened. It is taking longer to sell inventory (46 to 52 days) and longer to collect cash from customers (37 to 42 days). This could put a strain on cash flow. At the same time, its financial risk has increased as the gearing ratio has risen from 40% to 46.7%, indicating a greater reliance on debt financing.

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