Ratio Consolidated Eng

Topic Overview
Topic BAFS (Compulsory Part)

Introduction to Accounting – Basic Ratio Analysis
Level S4
Duration 8 lessons (40 minutes per lesson)
Learning Objectives:
1. Understand the concept and general function of accounting ratios.

2. Understand the calculation and interpretation of following financial ratios:
gross profit margin, net profit margin, return on capital employed, working
capital, current ratio and acid test ratio.
3. Use accounting ratios to evaluate a company’s profitability and liquidity.
Overview of Contents:
Lesson 1 Concept of Financial Statement Analysis
Lesson 2 Concept and General Function of Accounting Ratios
Lesson 3 Calculation and Interpretation of Profitability Ratios
(Gross Profit and Net Profit Margin)
Lesson 4 Calculation and Interpretation of Profitability Ratios
(Return on Capital Employed)
Lesson 5 Working Capital and Its Management
Lesson 6 Liquidity Position and Liquidity Problems
Lesson 7 Calculation and Interpretation of Liquidity Ratio
(Current Ratio and Acid-test Ratio)
Lesson 8 Evaluation on the Liquidity and Profitability of a
Business Using Accounting Ratios and Its Limitation
Resources:
 Topic Overview and Teaching Plan
 PowerPoint Presentation
 Student Worksheet
Suggested Activities:
 Group discussion
 In-class exercise
 Assignment
 Quiz

Lesson 1
Theme Concept of Financial Statement Analysis
Duration 40 minutes
Expected Learning Outcomes:
Upon completion of this lesson, students will be able to:

1. describe the basic concept of financial statement analysis.
Teaching Sequence and Time Allocation:

Activities Reference Time
Allocation
Part I: Introduction
 Teacher starts the lesson by a discussion. PPT #2 – 3 6 minutes
 Teacher invites students to share their ideas on
how to evaluate the performance of a business.
Part II: Content
 Teacher explains the concept of financial PPT #4 – 6 6 minutes
analysis and different types of users of financial
report.
 Teacher describes the format and contents of PPT #7 – 9 6 minutes
income statement which is used for financial
analysis.
 Activity 1: Class discussion
 Teacher invites students to share their PPT #10 3 minutes
ideas on how to evaluate a business with
an income statement. PPT #11 4 minutes
 Teacher goes through the answer and
makes conclusion.
 Teacher describes the format and contents of PPT #12 – 14 6 minutes
statement of financial position which is used for
financial analysis.
 Teacher asks students to compare income PPT #15 3 minutes
statement and statement of financial
position.
 Teacher goes through the answer and PPT #16 4 minutes
makes conclusion.
Part III: Conclusion
 Teacher concludes the lesson by reviewing the 2 minutes
key points covered.
Lesson 2
Theme Concept and General Function of Accounting Ratios
Duration 40 minutes

1. describe the general concept and function of accounting ratios.

Allocation
 Teacher explains financial statement analysis is PPT #2 – 3 3 minutes
a vital part of internal analysis and introduces
four areas for financial analysis.
Part II: Content
ideas on the performance of the business
based on the four areas for financial
analysis.
makes conclusion.
 Teacher explains the purpose of financial PPT #6 – 7 7 minutes
analysis using ratios.
 Teacher explains the three types of comparison PPT #8 – 11 9 minutes
for analysis.
 Activity 2: Group Discussion
 Students are divided into groups of three PPT #12 8 minutes
to four for discussion.
 Teacher invites students to share their PPT #13 – 14 4 minutes
ideas and makes conclusion.
key points covered.
Lesson 3
Theme Calculation and Interpretation of Profitability Ratios (Gross Profit
and Net Profit Margin)
Duration 40 minutes

1. calculate gross profit margin and net profit margin;
2. analyse and comment on these profitability ratios.

Allocation
 Teacher recaps the four areas for financial PPT #2 2 minutes
analysis and explains to students the discussion
of the lessons will be focused on profitability
and liquidity of a business.
Part II: Content
 Teacher explains the concept of profitability PPT #3 – 5 8 minutes
ratios.
 Teacher explains the concept of gross profit PPT #6 – 8 8 minutes
margin and demonstrates its calculation and
provides comments on its result.
 Activity 1: Calculation of Gross Profit Margin
 Teacher asks students to calculate and PPT #9 3 minutes
comment the gross profit margin for two
years.
makes conclusion.
 Teacher explains the concept of net profit PPT #11 - 13 6 minutes
margin and demonstrates its calculation and
comments on its result.
 Activity 2: Calculation of Net Profit Margin
 Teacher asks students to calculate and PPT #14 3 minutes
comment the net profit margin for two
years.
 Teacher goes through answers and makes PPT #15 4 minutes
conclusion.
key points covered.
Lesson 4
Theme Calculation and Interpretation of Profitability Ratios (Return on
Capital Employed)
Duration 40 minutes

1. calculate the return on capital employed;
2. analyse and comment on the profitability ratio.

Allocation
 Activity 1: Group discussion
 Teacher starts with a discussion to recap PPT #2 6 minutes
students’ understanding of gross profit
margin and net profit margin.
makes conclusion.
Part II: Content
 Teacher explains the concept of return on PPT #4 – 6 12 minutes
capital employed, demonstrates its calculation
and comments on its result.
 Activity 2: Calculation of Profitability Ratio
 Teacher asks students to calculate the PPT #7 8 minutes
gross profit margin, net profit margin and
ROCE for XYZ Ltd.
makes conclusion.
 Teacher explains the purposes of using PPT #9 3 minutes
profitability ratios.
key points covered.
Lesson 5
Theme Working Capital and Its Management
Duration 40 minutes

1. understand the concept of working capital;
2. calculate the working capital of a company.

Allocation
 Teacher explains the concept of working PPT #2 2 minutes
capital.
Part II: Content
ideas on the implication of a negative
working capital.
makes conclusion.
 Activity 2: Calculation of Working Capital
 Students are required to calculate and PPT #5 4 minutes
comment the working capital of a
company.
makes conclusion.
 Teacher explains the causes of a change in PPT #7 – 10 9 minutes
working capital.
 Teacher explains the concept of working capital PPT #11 – 12 3 minutes
management.
 Teacher explains the relationship of working PPT #13 – 14 4 minutes
capital management and business solvency.
to four to discuss the implication of a
conservative working capital policy to a
company.
makes conclusion.
key points covered.
Lesson 6
Theme Liquidity Position and Liquidity Problems
Duration 40 minutes

1. understand the concept of working capital management and liquidity;
2. evaluate the liquidity of a company.

Allocation
 Teacher explains the concept of Liquidity. PPT #2 4 minutes
Part II: Content
 Teacher explains how to measure the liquidity PPT #3 3 minutes
of a company.
 Teacher explains what is liquid asset. PPT #4 3 minutes
 Teacher invites students to give some PPT #5 3 minutes
examples of liquid assets.
makes conclusion.
 Teacher explains the risks of a company when PPT #7 3 minutes
there is liquidity problem.
to four to discuss the signs of liquidity
problem.
makes conclusion.
 Teacher explains how a company cope with its PPT #10 3 minutes
liquidity problem.
key points covered.
Lesson 7
Theme Calculation and Interpretation of Liquidity Ratio (Current Ratio
and Acid-test Ratio)
Duration 40 minutes

1. calculate the liquidity ratio (current ratio);
2. analyse and comment on the current ratio.
3. calculate the liquidity ratio (acid test ratio);
4. analyse and comment on the acid test ratio.

Allocation
 Teacher introduces liquidity ratios. PPT #2 3 minutes
Part II: Content
 Teacher explains how to measure the liquidity PPT #3 2 minutes
of a company.
 Teacher explains the concept of current ratio PPT #4 – 7 7 minutes
and demonstrate its calculation and provides
 Activity 1: Calculation of Current Ratio
comment the current ratio of a company.
makes conclusion.
 Teacher explains the limitation of using current PPT #10 5 minutes
ratio.
 Teacher explains the concept of acid test ratio PPT #11 – 14 7 minutes
and demonstrate its calculation and provides
 Activity 2: Calculation of Acid Test Ratio
comment the acid test ratio of a company.
makes conclusion.
 Teacher explains the advantages and PPT #17 4 minutes
disadvantages of using acid test ratio.
key points covered.
Lesson 8
Theme Evaluation on the Liquidity and Profitability of a Business Using
Accounting Ratios and Its Limitation
Duration 40 minutes

1. evaluate the liquidity and profitability of a business using accounting ratio and
make business decision;
2. describe the limitation of using accounting ratios.

Allocation
 Teacher recaps the question which was asked in PPT #2 2 minutes
the first lesson and invites students to share
their learning experience.
 Teacher concludes that the use of accounting PPT #3 2 minutes
ratios can help a company to understand its
financial performance and financial position.
Part II: Content
 Teacher demonstrates how to work out PPT #4 – 6 9 minutes
different accounting ratios for a company and
make comments accordingly.

 Activity 1: Case Study
 Students are required to calculate the PPT #7 8 minutes
accounting ratios and make decision.
 Teacher goes through the answer and PPT #8 – 10 9 minutes
makes conclusion.
 Teacher explains other factors that affecting PPT #11 3 minutes
business decision.
 Teacher explains the limitations of accounting PPT #12 5 minutes
ratio analysis.
key points covered.
Teacher starts the lesson with the question above and explains to students that they will
learn how to evaluate a business’s performance using accounting ratios in the lessons
followed.
1 2
Teacher explains the three basic aspects to evaluate a business. Teacher explains the concept of financial analysis.
4
Teacher explains to students that it is required by Companies Ordinance that a company Teacher explains different types of users of financial reports.
must prepare income statement and statement of financial position every year.
5 6
Teacher explains the purpose of preparing income statement. Teacher describes the format and content of an income statement.
7
Teacher explains the following calculations: Teacher invites students to share their ideas.
Sales ‐ Cost of Sales = Gross Profit
The other (operating) expenses are then charged against gross profit to derive operating
profit.
i.e. Gross Profit – Operating Expenses = Operating Profit or Net Profit Before Interest
and Tax
9 10
Teacher makes conclusions and provides answer. Teacher explains the nature of statement of financial position.
11 12
Teacher describes the content of a statement of financial position. Teacher describes the content of statement of financial position including non‐current
assets, current assets, current liabilities, non‐current liabilities and equity.
14
Teacher asks students to compare income statement and statement of financial position Teacher makes conclusions and provides answer.
by their purpose, timeframe and major items.
15 16
17
Teacher explains financial statement analysis is a vital part of internal analysis which:
• Overall performance could be measured in financial terms.
• Indicates the extent to which it is achieving its objectives.
• It can help identifying areas of weakness and formulate appropriate strategies.
Financial statement analysis is also helpful in providing information for external users for
investment and financing decisions such as hold/buy/sell shares, assess credit
worthiness etc.
1 2
Teacher explains there are four areas for financial statements analysis: Teacher invites students to share their ideas on the performance of the business based
• Profitability: Is the business profitable? on the four areas for financial statement analysis tht learnt in the previous slides.
• Liquidity and efficiency: Is the trading position satisfactory?
• Solvency: Is the business able to meet its long‐term fixed expenses?
• Market prospects: Is the business funded properly and using these funds wisely?
3 4
Students are free to share their ideas regarding the four aspects. Some suggested
solutions may include:
Profitability: The profit after tax in 20X5 is $29,000 higher than 20X4. Teacher explains that ratio analysis is a quantitative analysis which is one of the
Liquidity: The company is able to meet its short‐term obligation because the total of elements in financial statements analysis. Qualitative analysis such as customers’
current assets is higher than the total of current liabilities for both 20X4 and 20X5. preference etc. is not covered in this course.
Solvency: The company is able to generate future revenues to meet its long‐term debts
because profits earned for 20X5 has already covered 67% (332/497) of the long‐term
loan.
Market prospects: No idea as there is no market information provided from the financial
statements above.
Teacher explains to students that conclusions drawn about the performance of a
business is limited if we just refer to the numbers presented on the financial statements.
To overcome such limitation, teacher can then introduce the concepts of accounting
ratios in financial analysis.
5 6
Teacher explains the need of comparative analysis.
Teacher elaborates the importance of comparison in financial statements analysis by
using the information provided in activity 1. For example, there is no meaning by
merely knowing sales for the year 20X5 is $1,850,000, the information is insufficient for
us to make any comments on the sales performance of the company. However, by
comparing the sales figures of 20X4 and 20X5, and knowing that there is an increase of
$290,000, we can understand that the sales performance of the company is better than
previous year.
7 8
Teacher explains the use of intracompany comparison. Teacher explains the use of intercompany comparison.
9 10
Teacher explains the use of industry averages comparison. Students are divided into groups of three for discussion. Teacher invites students to
share their ideas and makes conclusions (the next two slides).
11 12
Teacher explains the types of internal users and how financial ratios Teacher explains the types of external users and how financial ratios
assist their decision-making. assist their decision-making.
13 14
15
Teacher introduces the four types of ratio for financial analysis and explains to students
the discussion of the lessons will be focused on profitability and liquidity of a business.
1 2
Teacher explains the concept of profitability ratio. Teacher recaps the contents of the income statement and explains the four level of
profit for analysis.
3 4
Teacher introduces the 3 key profitability ratios that show the operating performance of Teacher explains the gross profit margin indicates margin between selling price and cost
a business in relation to its sales. Generally, the higher the better. of good sold.
5 6
Teacher distributes the financial statements of ABC Company to students and illustrates Teacher recaps the financial statements which had been discussed on last lesson and
how to work out the gross profit margin of the company for the year 20X4 and 20X5. illustrates how to work out the gross profit margin of the company for the year 20X4 and
20X5.
The Gross Profit Margin for ABC Ltd:
20X5: $915/$1,850 x 100% = 49.46%
20X4: $807/$1,560 x 100% = 51.73%
The GP margin in 20X5 is worse than 20X4 by reducing 2.27%.
For the calculations of GP margin for ABC Ltd, teacher can explain to students the
decline in GP % may due to lower in selling price because of keen competition or high
purchase costs for the year 20X5.
7 8
Teacher asks students to complete the calculation and provide comments on the result. Teacher makes conclusions and provides answer.
Remarks: The above is a general comment only and teacher can explain that there are
many reasons leading to an increase in GP margin such as an increase in selling price or
a better use of marketing strategy to promote sales etc.
9 10
Teacher explains the net profit margin indicates net income generated by each one Teacher illustrates how to work out the net profit margin of the ABC Company for the
hundred dollar of sales. The higher the margin, the higher the return on sales. year 20X4 and 20X5.
11 12
Teacher recaps the financial statements which had been discussed on last lesson and Teacher asks students to complete the calculation and provide comments on the result.
illustrates how to work out the net profit margin of the company for the year 20X4 and
20X5.
The Net Profit Margin for ABC Ltd:
20X5: $398/$1,850 x 100% = 21.51%
20X4: $359/$1,560 x 100% = 23.01%
The NP margin in 20X5 is worse than 20X4 by reducing 1.5%.
For the calculations of NP margin for ABC Ltd, teacher can explain to students the
decline in NP % may due to lower GP or high operating cost for the year 20X5.
13 14
Teacher makes conclusions and provides answer.
Remarks: the above is a general comment only and teacher can explain that there are
many reasons leading to a decrease in NP margin such as an unexpected increase in rent
or salaries or the strategic increase in marketing expense to build up the company
image.
15 16
Teacher starts with a discussion to recap students’ understanding of gross profit margin
and net profit margin.
Students are invited to present their ideas.
1 2
Teacher makes conclusions and provides answer. Teacher explains the concept and formula of ROCE and its indication.
Teacher then introduce the concept of ROCE which is another ratio to assess the In general, the higher the ratio, the better the ability a company using its capital.
profitability of a company.
3 4
Teacher recaps the financial statements which had been discussed on last lesson and Teacher explains that from the perspective of the resources providers of the company, it
illustrates how to work out the ROCE of the company for the years 20X4 and 20X5. is very important to have adequate return to their investments. Besides, teacher should
explain the inter‐company comparison may be distorted if the result of an EBIT is not
The ROCE for ABC Ltd: used as the numerator .
20X5: $424/$3,483 x 100% = 12.17%
20X4: $383/$3,394 x 100% = 11.28%
The ROCE in 20X5 is better than 20X4 by increasing 0.89% which indicates a more
effective use of the company’s capital.
5 6
Teacher asks students to calculate the profitability ratios including gross profit margin, Teacher goes through the above and explore other alternative answers in the
net profit margin and ROCE for the two years of XYZ Ltd. “comments” column with students. For example, if the gross profit margin decline, it
may due to a lower selling price for competition or a higher cost in purchase. Teacher
may also highlight the GP will also affect the NP margin as NP is calculated by GP – Op
Exp.
7 8
Teacher explains the advantages of using profitability ratios.
9 10
Teacher explains the concept of working capital.
1 2
Teacher invites students to share their ideas. Teacher makes conclusions and provides answer.
3 4
Teacher asks students to calculate the working capital for XYZ Ltd. Teacher explains the implication of the following:
A positive working capital indicates that the company has sufficient fund to settle short‐
term obligations.
A negative working capital indicates that the company does not have sufficient
immediate fund to settle short‐term obligations. However, it does not mean the
company is insolvent as the company can settle short‐term obligations by using long‐
term finance.
Teacher explains the increase in working capital in 20X5 for XYZ Ltd indicates the ability
of using available fund to settle short‐term obligations has improved.
5 6
Teacher explains with examples the situations that will increase the working capital.
7 8
Teacher explains with examples the situations that will not change the working capital. Teacher invites students to answer and makes conclusion as below:
Sales of goods on credit only increase the trade receivable, the cash would not increase
since it has not yet been received.
Company will receive cash for sales of a non‐current asset. The loss on disposal is just an
accounting calculation.
Payment of dividend to shareholders and settlement to suppliers incur cash outflow.
Therefore, the answer is B.
9 10
Teacher explains the concept of working capital management. Teacher explains the importance of working capital management.
11 12
Teacher explains the relationship of working capital management and business solvency. Teacher describes two different working capital polices.
13 14
Students are divided into groups of three to four and and discuss the question. Teacher invites students to share their answers and debrief the suggested solution.
Teacher also explains that an aggressive policy will lead to an opposite effect.
15 16
17
Teacher explains the concept of liquidity.
1 2
Teacher explains how to measure the liquidity of a company.
Teacher explains what is liquid asset.
3 4
Teacher invites students to share their answers. Teacher makes conclusions and provides answer.
Teacher also explains that prepayment is not liquid asset as it cannot be converted in
cash but just an entitlement to receive goods or services in future.
5 6
Teacher explains the risks of a company when there is liquidity problem. Students are divided into groups of three to four and discuss the signals of liquidity
problem.
7 8
Teacher makes conclusions and provides answer. Teacher explains the common ways to cope with liquidity problems in companies.
9 10
11
Teacher introduces liquidity ratios.
1 2
Teacher explains the concept of current ratio.
Teacher introduces the use of current ratio and acid-test ratio which
help to measure the liquidity of a company.
3 4
Teacher explains current ratio indicates a company’s short‐term debt‐paying ability. A Teacher explains the implications of having too high or too low current ratio to a
higher ratio means greater liquidity. company.
5 6
Teacher reaps the financial statements which had been discussed on first lesson and Teacher asks students to complete the calculation and provide comments on the result.
illustrate how to work out the current ratios of the company for the years 20X4 and
20X5.
The current ratio for ABC Ltd:
20X5: $634/$351= 1.81 times
20X4: $700/$306 = 2.29 times
The current ratio for 20X5 is lower than 20X4 which indicates the ability to settle short‐
term debts is lower. However, it is still satisfactory as it still has sufficient liquidity to
cover its liabilities.
7 8
Teacher makes conclusions and provides answer. Teacher explains the liquidity problem of inventory and introduces the concept of acid
Teacher can remark that further investigations can be performed to identify the reasons test ratio in next slide.
for the decrease in current ratio such as decline in sales which makes the decline in
accounts receivable.
9 10
Teacher explains the concepts of acid test ratio. Teacher explains quick ratio indicates a company’s immediate short‐term debt‐paying
ability.
The rule of thumb for the quick ratio is 1:1
11 12
Teacher explains the indications of too high or too low of the acid test ratio. Teacher reaps the financial statements which had been discussed on first lesson and
illustrate how to work out the acid test ratios of the company for the years 20X4 and
20X5.
The acid test ratio for ABC Ltd:
20X5: ($634 ‐ $212)/$351= 1.20 times
20X4: ($700 ‐ $189)/$306 = 1.67 times
The acid test ratio for 20X5 is lower than 20X4 which indicates the ability of a company
to meet its liabilities without having to dispose its inventory is lower. However, it is still
satisfactory as it still has sufficient quick assets to cover its liabilities.
13 14
Teacher asks students to complete the calculation and provide comments on the result. Teacher makes conclusions and provides answer.
15 16
Teacher explains the advantages and disadvantages of using current ratio.
17 18
Teacher recaps the question which was asked in the first lesson and invites students to
share their learning experience after the learning of accounting ratios.
1 2
Teacher concludes that the use of accounting ratios can help a company to understand Teacher asks students to work out different accounting ratios for their uncle and make
its financial performance and financial position and to make economic decision. comments accordingly.
3 4
Teacher calculates different ratios and comments the results with students. Teacher calculates different ratios and comments the results with students.
5 6
Students are required to calculate the accounting ratios and suggest a situation for their
uncle.
7 8
Teacher goes through the answers and makes comments. Teacher explains the decision may be varied because there are other factors to be
considered in making business decision.
9 10
Teacher explains other factors that affecting business decision and remarks that the use
of accounting ratios is just one of the techniques to evaluate a business. Teacher can
then bring up the concept of limitation of using accounting ratios. Teacher explains the limitations of accounting ratio analysis.
11 12
13
BAFS (Compulsory Part) – Introduction to Accounting
Basic Ratio Analysis
Lesson 1
Activity 1 - Class Discussion
What can we know by reviewing a company’s income statement?
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Lesson 1

A company’s financial statements consist of the income statement and statement of
financial position. Compare these two statements.
Income statement Statement of financial position

Purpose
Time frame
Major item
Lesson 2
Activity 1 – Discussion
Your uncle has then provided you with the income statement and statement of financial
position of his business for the last two financial years for your viewing.
ABC Ltd
Income Statement
For the year ended 31 December
20X5 20X4
$'000 $'000
Turnover 1,850 1,560
Cost of sales (935) (753)
Gross profit 915 807
Expenses
Distribution (135) (108)
Selling and marketing (182) (161)
General and administrative (174) (155)
Operating profit 424 383
Interest expenses (26) (24)
Profit before tax 398 359
Income tax expenses (66) (56)
Profit after tax 332 303
ABC Ltd
Statement of Financial Position
As at 31 December
20X5 20X4
$'000 $'000
Non-current assets
Equipments 3,200 3,000
Current assets
Inventories 212 189
Trade receivables 304 286
Cash and bank 118 225
634 700
Current liabilities
Trade payables 285 250
Tax payable 66 56
351 306
Total assets less current liabilities 3,483 3,394
Financed by:
Share capital 2,200 2,200
Retained earnings 786 454
2,986 2,654
Non-current liabilities
Long-term loan 497 740
3,483 3,394
Using the four aspects of financial statement analysis, what can you find out from the
information provided on the financial statements?
Profitability: Liquidity and Efficiency:
Solvency: Market Prospects:

BAFS (Compulsory Part) –
Introduction to Accounting
Lesson 2
Activity 2 – Group discussion
Divided into three groups which represent the 1. internal management; 2. lenders; 3.
shareholders (investors) of a company and discuss how the financial ratios can help
you to make business decisions?
Internal Management:
Lenders:
Shareholders (Investors):
Lesson 3
Activity 1 - Calculation of Gross Profit Margin
Given the following information, calculate and comment the gross profit margin for
the years of 20X4 and 20X5.
20X4 20X5
Sales $100,000 $120,000
Cost of goods sold $54,000 $62,000
Gross profit ( ) ( )
Gross profit margin ( ) ( )
Comments:
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Lesson 3
Activity 2 - Calculation of Net Profit Margin
Given the following information, calculate and comment the net profit margin for
the years of 20X4 and 20X5.
20X4 20X5
Sales $100,000 $120,000
Cost of goods sold $54,000 $62,000
Gross profit $46,000 $58,000
Operating expenses $33,000 $44,000
Net profit ( ) ( )
Net profit margin ( ) ( )
Comments:
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Lesson 4
Activity 1 – Class Discussion
What are the differences between

gross profit margin and net profit
margin?
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Lesson 4
Activity 2 – Calculation of Profitability
Refer to the financial statements of XYZ Ltd, calculate and comment its profitability
ratios.
XYZ Ltd
Income Statement
20X5 20X4
$'000 $'000
Sales 3,310 2,952
Cost of sales (1,840) (1,632)
Gross profit 1,470 1,320
Expenses
General and (227) (187)
XYZ Ltd
As at 31 December
20X5 20X4
$'000 $'000
Non-current assets
Current assets
Inventories 331 292
1,057 863
Current liabilities
Tax payable 92 96
488 463
Financed by:
Retained earnings 1,022 855
5,022 4,855
Long-term loan 1,047 765
6,069 5,620
Calculations Comments
Gross Profit Margin
20X5:
20X4:
Net Profit Margin
20X5:
20X4:
Return on Capital Employed
20X5:
20X4:
Lesson 5
Companies should have a positive amount of working capital, i.e. current assets are
greater than current liabilities.
What happens if there were a negative working capital (i.e. current assets < current
liabilities)?
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Lesson 5
Activity 2 – Calculation of Working Capital
Refer to the financial statements of XYZ Ltd, calculate its working capital.
XYZ Ltd
Income Statement
20X5 20X4
$'000 $'000
Sales 3,310 2,952
Cost of sales (1,840) (1,632)
Expenses
General and (227) (187)
XYZ Ltd
As at 31 December
20X5 20X4
$'000 $'000
Non-current assets
Current assets
Inventories 331 292
1,057 863
Current liabilities
Tax payable 92 96
488 463
Financed by:
Retained earnings 1,022 855
5,022 4,855
6,069 5,620
Working Capital of XYZ Ltd
20X5:
20X4:
BAFS
Ratio Analysis 5
Activity 3 – Group Discussion
How a conservative working capital policy lowers profitability and risk?
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Lesson 6
Can you give some other examples of liquid

assets?
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Lesson 6
Activity 2 – Group Discussion
How can we know if a company has a liquidity problem?
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Lesson 7
Activity 1 - Calculation of Current Ratio
Given the following information, calculate and comment the current ratio for the years of
20X4 and 20X5.
20X4 20X5
Inventory $163,000 $116,000
Accounts $146,000 $162,000

receivable
Cash and bank $23,000 $44,000
Accounts payable $155,000 $171,000
Calculations Comments
Current ratio
20X4:
20X5:
Lesson 7
Activity 2 - Calculation of Acid Test Ratio
Given the following information, calculate the acid test ratio for the years of 20X4 and 20X5
and comment the ratio by comparing with the current ratio calculated in activity 1.
20X4 20X5
Inventory $163,000 $116,000
Accounts receivable $146,000 $162,000
Cash and bank $23,000 $44,000
Accounts payable $155,000 $171,000
Current ratio Acid test ratio Comments
20X4: 20X4:
20X5: 20X5:
Lesson 8
Activity 1 – Case Study
Your uncle’s business is the supplier of DEF Ltd. Your uncle is now considering
whether it is appropriate to sell goods to DEF Ltd on credit or COD (Cash on Delivery).
(Demanding COD might cause DEF Ltd buy less from your uncle’s company.)
Use accounting ratios to help your uncle to make decision
Cost of sales (3,380) (3,410)

Expenses
General and
(331) (303)
administrative
DEF Ltd
As at 31 December
20X5 20X4
$'000 $'000
Non-current assets
Current assets
Inventories 338 284
908 818
Current liabilities
Tax payable 65 42
847 476
Financed by:
Retained earnings 1,688 1,288
7,188 6,788
8,311 7,615
20X5 Ratio Calculation Result
Gross Profit Margin
Net Profit Margin
ROCE
Current Ratio
Acid Test Ratio
20X4 Ratio Calculation Result
Gross Profit Margin
Net Profit Margin
ROCE
Current Ratio
Acid Test Ratio

Ratio Comments
Gross Profit Margin
Net Profit Margin
ROCE
Current Ratio
Acid Test Ratio
Suggestion
______________________________________________
______________________________________________
______________________________________________
______________________________________________
______________________________________________
______________________________________________
______________________________________________
______________________________________________
______________________________________________
______________________________________________
Basic Ratio Analysis – Home Assignment

Section A: Multiple Choice Questions (@1, total 10 marks)
1. Why does financial analysis involve the expression of the reported numbers in
relative term?
A. It is easy to calculate.
B. It helps users to make comparison on the same basis.
C. Absolute numbers are difficult to identify.
D. All of the above.
Level of difficulty: **
2. Which of the following cannot be ascertained from an income statement of a

company?
A. Sales generated for the year.

B. Share price of the company.
C. Profit for the year.
D. Operating expenses of the year.
Level of difficulty: *
3. A ratio by itself may have no meaning. Hence, a given ratio is compared to:
A. Ratios from previous years

B. Ratios of other companies
C. Both A and B.
D. None of the above.
4. The shareholders of the company will analyse the financial statement of the
company and
A. decide whether or not to invest in a company.

B. determine a company’s credit worthiness.
C. evaluate performance of employee and determine relevant compensation.
D. understand the financial performance of the company’s competitors.
p.1
5. A ___________ ratio is a measure of how profitable a company is in doing its

business.
A. profitability.
B. liquidity.
C. solvency.
D. investment.
6. Which of the following is the best description for return on capital employed
(ROCE)?
A. It describes a company’s ability to earn a net income from sales.

B. It is the difference between current assets and current liabilities
C. It is defined as the ability to pay your debts when they come due.
D. It is a measure of efficiency of a company in using its capital to generate profit.
7. Given the following information, calculate the working capital.

Office equipment: $85,000
Furniture & fixture: $24,000
Accounts receivable: $5,200
Inventory: $6,100
Bank overdraft: $1,500
Accounts payable: $4,400
A. $5,400.
B. $8,400.
C. $114,400.
D. $117,400.
p.2
8. Which of the following description about current ratio is correct?
A. A ratio of 0.8:1 means a company will be liquidated.

B. The higher the ratio the better.
C. Accounts receivables are assumed to be collected on a timely basis.
D. The non-current assets can be sold immediately when there is a liquidity
problem.
9. Other than the use of accounting ratios, which of the following factors will not
affect the decision of investing in another company?
A. Legal environment.
B. Reputation of the company.
C. Relationship with customers.
D. Research expenses already paid for this investment project.
Level of difficulty: ***
10. If the current ratio of a company is 7:1, the company may be holding
____________ idle short-term assets.
A. too much
B. too little
C. sufficient
D. right level of
p.3
Section B: Short Questions
Question 1
Briefly describe four internal uses of financial ratios to a company. (4 marks)
Question 2
What is the reason of using ‘profit before interest and tax’ instead of ‘profit after
interest and tax’ as the numerator in the ROCE formula? (4 marks)
Question 3
Suggest four methods to a company when there is a liquidity problem to settle the
balance with its supplier in next month. (8 marks)
Question 4
Given the following information, calculate the current ratio and acid test ratio of the
company and provide comment on its liquidity. (10 marks)
Non-current assets: $241,000

Accounts receivable: $6,300
Inventory: $15,500
Cash: $5,500
Accounts payable: $9,800
Tax payable: $3,200
p.4
Question 5
(a) State the characteristics of a company using aggressive working capital policy
byshowing its effects on the level of items listed in the following table. (4 marks)
(b) Briefly describe the overall impacts on profitability and risk to a company using
aggressive working capital policy by outlining its implication to the items listed
in the following table. (10 marks)
Level of Level of Level of Short-term Overall

cash accounts inventory debts/ Impact
receivable long-term
liabilities
(a) ----
Characteristics
(b)
Profitability
Risk
p.5
Solutions:
Section A: MCQs
1. B 2. B 3. C 4. A 5. A
6. D 7. A 8. C 9. D 10. A
Section B: Short Questions.

Question 1
The four internal uses of financial ratios include:
1. Identify deficiencies of the company and take remedial action.

2. Evaluate performance of employees and determine relevant compensation.
3. Compare the financial performance of different divisions within the company.
4. Understand the financial performance and status of the company’s competitors.
(@1, total 4 marks)
Question 2
The reason of using net profit before interest and tax in calculating ROCE is that such
profit is the income generated from the company’s assets regardless of how the
company’s funds come from.
If the company relies heavily on borrowing, the net profit before tax will be adversely
affected because of high interest expense and hence affect the comparison with
companies with different capital structure.
(@2, total 4 marks)
Question 3
A company might consider the following methods to cope with the liquidity
problems:
• Offering an early settlement discount to its customers. This is a reduction in
the amount of the payment required from the customer provided that the
customer pays within a specified time limit.
• Offering trade discount on cash sales to its customers for receiving immediate
cash.
• Buy less inventory = applying Just-in-time inventory system to reduce the
carrying cost of the inventory and increase the cash balance.
• Borrow a short to medium-term loan (e.g. 1 to 3 years) to enhance the liquidity.
[remarks: it is not suggested to use long-term loan as the interest expense will
be too high when it is only a temporary running short of cash.]
p.6
• Disposal of idle non-current assets to improve the liquidity.

• Any other valid suggestions.
(@2, max 8 marks)
Question 4
Calculation Comments
Current ($6,300 + $15,500 + The current ratio is satisfactory as the current
ratio $5,500) / ($9,800 + assets are about two times of its current
$3,200) = 2.1:1 liabilities which indicates the company has
(2 marks) sufficient short-term funds to settle its
short-term obligations. (2 marks)
Acid test ($6,300 + $5,500) / The acid test ratio is a bit unsatisfactory as there
ratio ($9,800 + $3,200) = is less than $1 dollar of liquid assets to cover $1
0.91:1 dollar of current liabilities. The significant
(2 marks) drop of the ratio indicates there are too many
inventories on hand and the company may not
have sufficient short-term funds without the
sale of inventory to settle its short-term
obligations. (4 marks)
Question 5
Level of Level of Level of Short-term Overall
cash accounts inventory debts/ Impact
receivable long-term
liabilities
(a) Lower Lower Lower Higher/lower -
Characteristics
(b) Increase Less cost Lower Lower Higher
Profitability investment of carrying costs interest return
opportunity. financing and expenses.
when cash obsolescence.
is
received.
Risk Higher risk Higher Probability of More Higher
as less probably stock out and short-term risk
immediate of bad miss the obligation to
cash. debts. chance of meet.
sales.
(@1, total 14 marks)
p.7
Ratio Analysis
Basic Ratio Analysis – Quiz

Section A: Multiple Choice Questions (@1, total 10 marks)
1. Which of the following issue can be indicated by reviewing the income statement
of a company?
A. The operating expense spent for the year in percentage of the income for the
year.
B. How much non-current asset is employed to generate profit.
C. Whether the debt level is high or low.
D. Whether the company is able to pay for their short-term obligation.
2. What can be showed by comparing a computer company’s the financial

information over the past 5 years?
A. Trends of financial performance.

B. Company’s competitive position.
C. Development of the industry.
D. Technological change.
3. What is the implication of having a higher return on capital employed (ROCE)?
A. The company has a better control on cost of goods sold.

B. The company is able to settle its short-term loan.
C. The company relies too much on capital.
D. The company is more effective in using its capital assets to generate returns.
p. 1
Ratio Analysis
4. Which of the following may be affected by the profitability of a company?
A. Its ability to obtain debt and equity financing

B. Its liquidity position.
C. Its ability to grow.
D. All of the above.
5. What is the implication when a company has high gross profit but low net profit?
A. Poor control on working capital.

B. Better control on cost of goods sold and operating expense.
C. Better control on cost of goods sold but poor control on operating expense.
D. Decline in sales demand.
6. Which of the following would lead to an immediate outflow of cash in a period?
A. Purchase of goods on credit.

B. Payment to suppliers.
C. Unpaid dividend declared.
D. Receipt from customers.
7. By using aggressive working capital policies, current assets are often financed by
___________.
A. Selling non-current assets.

B. Borrowing short-term debts.
C. Issuing bonds.
D. Issuing shares.
p. 2
Ratio Analysis
8. Which of the following is not a component of working capital?
A. Plant and machinery.

B. Cash.
C. Trade payables.
D. Inventory.
9. Which of the following is not a component of quick assets?
A. Trade receivable.
B. Cash.
C. Inventory.
D. None of the above.
10. Which of the following is not the limitation of financial ratio analysis?
A. Seasonal factor cannot be reflected.

B. Information used are historical.
C. Different accounting practices adopted by companies.
D. Too much accounting information included.
p. 3
Ratio Analysis
Section B: Short Questions
Question 1
Briefly describe the signs of liquidity problems of a company. (10 marks)
Question 2
Calculate the following financial ratios for XYZ Ltd for both 20X4 and 20X5, and
comment briefly the result of each ratio.
 Gross profit margin.

 Net profit margin.
 Return on capital employed.
 Current ratio.
 Acid test ratio.
XYZ Ltd
Income Statement
20X5 20X4
$'000 $'000
Sales 23,220 20,123
Cost of sales (16,420) (14,836)
Expenses
Selling and marketing (1,322) (1,201)
General and (1,054) (988)
Operating profit 3,526 2,394
Profit before tax 3,091 2,062
Profit after tax 2,635 1,708
p. 4
Ratio Analysis
XYZ Ltd
As at 31 December
20X5 20X4
$'000 $'000
Non-current assets
Current assets
Inventories 1,564 1,186
Trade receivables 2,349 2,561
4,764 4,105
Current liabilities
Trade payables 1,894 2,334
Tax payable 456 354
2,350 2,688
Financed by:
Retained earnings 8,515 5,880
38,515 35,880
Long-term loan 9,104 7,621
47,619 43,501
(20 marks)
p. 5
Ratio Analysis
Solutions:
Section A: MCQs
1. A 2. A 3. D 4. D 5. C
6. B 7. B 8. A 9. C 10. D
Section B: Short Questions.

Question 1
The signs of liquidity problems of a company include:
1. Persistent decline in daily or weekly cash inflows.

2. Significant decline in operating profit which indicates the company is unable to
pass the cost on to customers.
3. Unexpected build-up of accounts receivable and inventory which indicates the
company may not be able to collect money from customers or is unable to sell
goods.
4. Unexpected build-up of accounts payable indicates the company is unable to pay
to its suppliers.
5. Shape decline in company’s working capital.
(@2, total 10 marks)
Question 2
Formula 20X5 20X4

Gross Gross profit / $6,800/$23,220 = 29.29% $5,287/$20,123 = 26.27%
profit Sales
margin
Comment: The gross profit margin for 20X5 is better than 20X4 which indicates a
better control on purchase costs (e.g. good bargain with suppliers) and/or
better sales performance of the company.
Net profit Net profit $3,091/$23,220 = 13.31% $2,062/$20,123 = 10.25%
margin before tax /
sales
Comment: The net profit margin for 20X5 is better than 20X4 which indicates a
better control on purchase costs and/or operating expenses and/or better
sales performance of the company..
ROCE PBIT / Average $3,526/$47,619 = 7.4% $2,394/$43,501= 5.5%
p. 6
Ratio Analysis
capital
employed
Comment: The ROCE for 20X5 is better than 20X4 which indicates the company is
more efficient in using its capital asset to generate income.
Current Current $4,764/$2,350 = 2.03:1 $4,105/$2,688 = 1.53:1
ratio assets/Current
liabilities
Comment: There is an increase in current ratio which indicates the ability of the
company to settle its short-term debts is improved. Besides, the current
ratio suggests that the company has sufficient current assets to meet its
short term debts.
Acid test (Current ($4,764 - $1,564)/$2,350 = ($4,105 - $1,186)/$2,688
ratio assets – 1.36:1 = 1.09:1
Inventory)/
Current
liabilities
Comment: There is an increase in acid test ratio which indicates the ability of the
company to use settle its short-term debts without having disposed of its
inventory is improved. Besides, the acid test ratio suggests that the
company has sufficient liquid assets to meet its short term debts.
(1 mark for each ratio and 2 marks for each comment, total 20 marks)
p. 7

Ratio Consolidated Eng

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Topic Overview

Topic BAFS (Compulsory Part)

1. Understand the concept and general function of accounting ratios.

Expected Learning Outcomes:

Upon completion of this lesson, students will be able to:

Teaching Sequence and Time Allocation:

Expected Learning Outcomes:

Upon completion of this lesson, students will be able to:

Teaching Sequence and Time Allocation:

Expected Learning Outcomes:

Upon completion of this lesson, students will be able to:

Teaching Sequence and Time Allocation:

Expected Learning Outcomes:

Upon completion of this lesson, students will be able to:

Teaching Sequence and Time Allocation:

Expected Learning Outcomes:

Upon completion of this lesson, students will be able to:

Teaching Sequence and Time Allocation:

Expected Learning Outcomes:

Upon completion of this lesson, students will be able to:

Teaching Sequence and Time Allocation:

Expected Learning Outcomes:

Upon completion of this lesson, students will be able to:

Teaching Sequence and Time Allocation:

Expected Learning Outcomes:

Upon completion of this lesson, students will be able to:

Teaching Sequence and Time Allocation:

The Gross Profit Margin for ABC Ltd:

The Net Profit Margin for ABC Ltd:

Teacher explains what is liquid asset.

Activity 2 - Class Discussion

Income statement Statement of financial position

Total assets less current liabilities 3,483 3,394

Profitability: Liquidity and Efficiency:

Solvency: Market Prospects:

Activity 2 – Group discussion

Activity 2 - Calculation of Net Profit Margin

What are the differences between

Activity 2 – Calculation of Profitability

Total assets less current liabilities 6,069 5,620

Gross Profit Margin

Net Profit Margin

Return on Capital Employed

Activity 2 – Calculation of Working Capital

Total assets less current liabilities 6,069 5,620

Working Capital of XYZ Ltd

Activity 3 – Group Discussion

How a conservative working capital policy lowers profitability and risk?

Can you give some other examples of liquid

Activity 2 – Group Discussion

How can we know if a company has a liquidity problem?

Inventory $163,000 $116,000

Accounts $146,000 $162,000

Accounts payable $155,000 $171,000

Inventory $163,000 $116,000

Accounts receivable $146,000 $162,000

Cash and bank $23,000 $44,000

Accounts payable $155,000 $171,000

Current ratio Acid test ratio Comments

Cost of sales (3,380) (3,410)

Total assets less current liabilities 8,311 7,615

Gross Profit Margin

Net Profit Margin