How to use this sheet
Ratios on their own mean nothing. A current ratio of 1.5 is healthy for a manufacturer but worrying for a retailer. Always compare: against the industry, against the firm's prior year, against a competitor. That's where the marks are.
Profitability ratios
| Ratio | Formula | Good range |
|---|---|---|
| Gross profit margin (GPM) | (Gross profit / Sales) × 100 | 30 to 60% (varies wildly by industry) |
| Net profit margin (NPM) | (Net profit / Sales) × 100 | 5 to 20%+ |
| ROCE | (Net profit before tax & interest / Capital employed) × 100 | 15 to 25%+ |
Interpretation tip: a high GPM but low NPM signals fixed-cost or overhead problems. A high NPM but low ROCE signals under-utilised capital.
Liquidity ratios
| Ratio | Formula | Good range |
|---|---|---|
| Current ratio | Current assets / Current liabilities | 1.5 to 2.0 |
| Acid test / Quick ratio | (Current assets − Stock) / Current liabilities | 0.7 to 1.0 |
Both below 1.0 = potential cash flow distress. Both significantly above 2.0 = idle assets that could be invested.
Efficiency ratios
| Ratio | Formula | Good range |
|---|---|---|
| Stock turnover | Cost of goods sold / Average stock | 4 to 12× per year (depends on industry) |
| Debtor days | (Debtors / Sales) × 365 | 30 to 60 days |
| Creditor days | (Creditors / Cost of sales) × 365 | 30 to 60 days |
Gearing
Gearing = (Long-term liabilities / Capital employed) × 100. Above 50% = highly geared = vulnerable to interest rate changes. Below 25% = under-geared = potentially missing leverage opportunities.
Comparing ratios
Three comparisons examiners look for:
- Year-on-year: has the ratio improved or worsened?
- Industry benchmark: is the firm above or below the norm?
- Competitor: head-to-head with a similar firm.
Adding evaluation in Paper 2
The pattern that earns top-band marks:
"Firm X's current ratio has fallen from 1.8 to 1.1 over two years (calculation), signalling worsening liquidity. However, this is partly explained by [stimulus context, e.g. recent inventory expansion]. On balance, the trend is concerning but defensible in the short term."
Notice the order: calculate, interpret, contextualise, judge. Four sentences that cover the whole descriptor.
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