Financial statements and ratios

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Income statement over a period

A simplified trading income statement starts with revenue, subtracts cost of sales for gross profit, and subtracts other operating expenses for operating profit. Finance costs and tax may then be deducted to reach explicitly labelled later profit measures. Follow the question’s net-profit definition; school specifications differ in terminology.
An income statement is also called a profit and loss account. A statement of comprehensive income can include other comprehensive income in addition to profit or loss, so the titles are not exact synonyms in full accounting. This lesson uses a simplified income statement and does not teach those additional accounting items.

Simplified annual income statement

Statement of financial position

The statement of financial position reports assets, liabilities and equity at one date. Current assets include cash, ordinary inventory, short-term receivables and suitable prepayments; non-current assets include longer-term machinery or premises. Current classification can follow the operating cycle as well as the usual twelve-month distinction.
Current liabilities include ordinary trade payables and amounts due shortly. Split a long-term loan where necessary: the portion due in the coming twelve months is normally current and the remainder non-current in this simplified setting. Equity = total assets − total liabilities; retained profit is not a separate cash pot.
In the fictional snapshot, non-current assets £150,000 plus current assets £100,000 give £250,000 assets. Current liabilities £50,000 plus non-current liabilities £20,000 give £70,000 liabilities, leaving £180,000 equity. Capital employed for this example is £180,000 + £20,000 = £200,000.

Financial position at year end

Ratios

Gross margin = gross profit ÷ revenue × 100. Net margin = the specified net-profit figure ÷ revenue × 100. Use consistent definitions and nonzero denominators. A supplied net-profit figure can be used directly without inventing additional deductions.
Extension formulas, depending on qualification: ROCE = operating profit ÷ capital employed × 100; current ratio = current assets ÷ current liabilities, stated as x:1. Here £20,000 operating profit ÷ £200,000 capital × 100 = 10%, and £100,000 current assets ÷ £50,000 current liabilities = 2:1. Neither measures a guaranteed investor cash payout.

Calculate from the stated inputs

Interpreting

Compare consistent periods, definitions and similar business models; investigate unusual items and accounting choices. Higher margins mean more profit per pound of revenue, but do not alone establish better overall performance or a better business strategy.
Fictional Year 1 gross profit £20,000 ÷ revenue £100,000 = 20%; Year 2 £24,000 ÷ £150,000 = 16%. Absolute gross profit rises despite a four-percentage-point margin fall. Price, cost and sales mix need investigating rather than inferring a unique cause.
A current ratio below 1:1 may signal liquidity risk, while a high ratio may contain slow-moving stock or overdue receivables. There is no universal ideal applicable to every sector. Use cash timing, finance availability and asset quality to judge payment capacity.

A lower margin need not mean less profit

Limitations

Historical accounts describe earlier periods and may not predict future conditions. Ratios can also use forecasts, which add estimation uncertainty. Accounting policies, reporting dates and different business models can limit comparability.
Ratios do not capture every non-financial influence, such as staff capability, customer experience or product quality. Window dressing can make reported numbers appear more favourable through timing or presentation. Use other evidence and avoid assuming every unusual figure proves wrongdoing.

Look beyond a 2:1 current ratio

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Soal latihan

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1.What is an asset?
Easy
- Aan economic resource controlled by the business
- Bsomething a business owes
- Crevenue
- Da cost
2.What is a liability?
Easy
- Asomething a business owns
- Brevenue
- Cprofit
- Dsomething a business owes
3.What is a non-current asset?
Easy
- Acash
- Breceivables
- Ca long-term asset like machinery
- Dstock
4.What is a current asset?
Easy
- Aequity
- Bcash or an asset expected to be sold, used or collected in the normal operating cycle or short term
- Ca building
- Da long-term loan
5.What are receivables?
Easy
- Amoney owed to the business by customers
- Bmoney owed to suppliers
- Ccash
- Dprofit
6.What are payables?
Easy
- Amoney owed by customers
- Bcash
- Cprofit
- Dmoney the business owes to suppliers
7.What is equity?
Easy
- Atotal costs
- Bthe bank balance
- Cthe owners' stake: assets minus liabilities
- Dtotal revenue
8.What is retained profit?
Easy
- Aa loan
- Bprofit kept in the business
- Cprofit paid out
- Drevenue

Soal lainnya

9.What does the income statement start with?
Easy
- Arevenue
- Bassets
- Cliabilities
- Dequity
10.What is operating profit?
Easy
- Arevenue minus tax
- Brevenue plus costs
- Cnet profit plus tax
- Dgross profit minus other operating expenses, before finance costs and tax
11.Extension: what does ROCE stand for?
Easy
- Arevenue over cost estimate
- Breturn on current equity
- Creturn on capital employed
- Drate of cash exchange
12.Extension: which formula calculates ROCE using operating profit?
Easy
- Aprofit minus tax
- Boperating profit divided by capital employed times 100
- Crevenue divided by costs
- Dassets divided by liabilities
13.Extension: which formula calculates the current ratio?
Easy
- Acurrent assets divided by current liabilities
- Bcurrent liabilities divided by assets
- Cprofit divided by revenue
- Drevenue divided by assets
14.Current assets £6,000 and current liabilities £3,000. Current ratio?
Easy
- A0.5:1
- B3:1
- C9:1
- D2:1
15.Extension: using operating profit ÷ capital employed × 100, calculate ROCE from £20,000 operating profit and £200,000 capital employed.
Easy
- A1%
- B0.1%
- C10%
- D20%
16.Gross profit £40,000 on revenue £160,000. Gross margin?
Medium
- A75%
- B25%
- C40%
- D4%
17.Extension: a current ratio of 0.5:1 may suggest what?
Medium
- Apossible liquidity problems
- Bstrong liquidity
- Chigh profit
- Dno debt
18.What can be concluded directly when gross profit margin rises?
Medium
- AAbsolute gross profit must rise
- BSelling prices must have risen
- CTotal debt must have fallen
- DMore gross profit remains per pound of revenue
19.Which compares ratios meaningfully?
Medium
- Awith nothing
- Bwith weather
- Cwith last year and with competitors
- Dwith random numbers
20.What is window dressing?
Medium
- Apaying tax
- Bmaking accounts look better than reality
- Ccleaning windows
- Dselling windows
21.Which is a limitation of ratio analysis?
Medium
- Ahistorical ratios may not predict future conditions
- Bit uses future data only
- Cit includes all non-financial factors
- Dit is always exact
22.What is a limitation of financial statement ratios used alone?
Medium
- Ait covers everything
- Bit predicts the future
- Cit is free
- Dthey do not capture every relevant non-financial factor
23.Which users read accounts?
Medium
- Aonly competitors
- Bno one
- Cshareholders and lenders
- Donly customers
24.Why do lenders look at the current ratio?
Medium
- Ato avoid risk entirely
- Bto judge ability to repay short-term debts
- Cto measure tax
- Dto measure sales
25.Why compare profit margins with competitors?
Medium
- Ato judge relative performance
- Bto measure tax
- Cto hide results
- Dto remove costs
26.Why might a high ROCE attract investors?
Medium
- Ait shows high losses
- Bit shows no profit
- Cit shows no assets
- Dit shows efficient use of capital
27.Why can a profitable firm have a low current ratio?
Medium
- Aliabilities are zero
- Bassets are zero
- Ccurrent assets may be low relative to current liabilities at the reporting date
- Dprofit equals cash
28.Which belongs in the income statement?
Easy
- Abuildings
- Bcost of sales
- Cstock
- Dequity
29.Which belongs in the statement of financial position?
Easy
- Acurrent assets
- Brevenue
- Ccost of sales
- Dsales discounts
30.Stock is a current asset.
Easy
True or false?
31.The statement of financial position shows profit over a year.
Easy
True or false?
32.Equity equals assets minus liabilities.
Easy
True or false?
33.A current ratio below 1 can indicate liquidity risk.
Easy
True or false?
34.Ratio analysis considers all non-financial factors.
Medium
True or false?
35.In an ordinary trading business, which are current assets in these stated uses? Select all that apply.
Medium
- AInventory held for sale
- BTrade receivables due shortly
- CCash available in the bank
- DPrepaid rent for the coming month
- EProduction machinery for long-term use
36.Which are ratios?
Medium
- Agross profit margin
- Bnet profit margin
- CROCE
- Dcurrent ratio
- Ebreak-even output
37.Evaluate the usefulness of ratio analysis.
Medium

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