A firm has current assets of 120,000 and current liabilities of 60,000. Calculate the current ratio. [2 marks]

A firm has operating profit of 150,000 and capital employed of 1,000,000. Calculate the ROCE. [2 marks]

WJEC Eduqas Eduqas 2020-style practice: A firm has revenue of 600,000, gross profit of 240,000 and operating profit of 90,000. Calculate the gross profit margin and the operating profit margin. (6)

A Component 2 calculation rewarding both formulae, working and percentages. Gross profit margin = gross profitrevenue × 100 = 240,000600,000 × 100 = 40\%. Operating profit margin = operating profitrevenue × 100 = 90,000600,000 × 100 = 15\%. Markers reward both correct margins with the percentage sign. A strong answer notes the gap between the two (40% to 15%) reflects operating expenses such as wages and overheads. The common error is to divide profit by costs rather than by revenue.

EnglandBusinessSyllabus dot point

What do the financial statements show, and how do ratios judge performance?

The income statement and statement of financial position; profitability ratios (gross and net profit margin, ROCE); liquidity ratios (current ratio, acid test); gearing; the calculation and interpretation of ratios; and their value and limitations.

A focused answer to the Eduqas A-Level Business statement on financial statements and ratios. Covers the income statement and statement of financial position, profitability ratios (gross and net margin, ROCE), liquidity ratios (current and acid test), gearing, the calculation and interpretation of ratios, and their value and limitations, with worked calculations.

Generated by Claude Opus 4.813 min answerUpdated 2026-06-02

Reviewed by: AI editorial process; not yet individually human-reviewed

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Quick answer

The income statement shows revenue, costs and profit over a period (gross profit, operating profit, profit for the year). The statement of financial position (balance sheet) shows assets, liabilities and capital at a point in time. Profitability ratios: gross profit margin $\tfrac{\text{gross profit}}{\text{revenue}} \times 100$ , net (operating) profit margin $\tfrac{\text{operating profit}}{\text{revenue}} \times 100$ , and ROCE $\tfrac{\text{operating profit}}{\text{capital employed}} \times 100$ . Liquidity ratios: current ratio $\tfrac{\text{current assets}}{\text{current liabilities}}$ and acid test $\tfrac{\text{current assets} - \text{inventory}}{\text{current liabilities}}$ . Gearing $\tfrac{\text{non-current liabilities}}{\text{capital employed}} \times 100$ measures reliance on debt. Ratios are most useful compared over time and against benchmarks, but rest on historic data and ignore qualitative factors.

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What this theme is asking
The financial statements
Profitability ratios
Liquidity ratios
Gearing
Value and limitations of ratio analysis
Examples in context
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What this theme is asking

Eduqas wants you to understand the two main financial statements, calculate and interpret the key ratios (profitability, liquidity, gearing), and judge the value and limitations of ratio analysis. Ratios turn raw numbers into comparable measures that judge whether a business is profitable, liquid and not over-borrowed, and they are central to Component 2.

The financial statements

Profitability ratios

Liquidity ratios

Gearing

Gearing measures how much of the firm's capital comes from debt (borrowing) rather than equity:

\text{Gearing} = \frac{\text{non-current liabilities}}{\text{capital employed}} \times 100

Above $50\%$ is highly geared: the firm relies heavily on debt, raising financial risk (interest must be paid in good times and bad) but potentially boosting shareholder returns. Below $25\%$ is low geared and lower risk. Lenders and investors watch gearing closely.

Worked example: calculating and interpreting key ratios

A firm reports: revenue $\pounds 800{,}000$ , gross profit $\pounds 320{,}000$ , operating profit $\pounds 120{,}000$ , capital employed $\pounds 600{,}000$ , current assets $\pounds 90{,}000$ (including inventory $\pounds 30{,}000$ ) and current liabilities $\pounds 60{,}000$ .

step 1: gross and operating margins

\text{Gross margin} = \frac{320{,}000}{800{,}000} \times 100 = 40\%

\text{Operating margin} = \frac{120{,}000}{800{,}000} \times 100 = 15\%

step 2: ROCE

\text{ROCE} = \frac{120{,}000}{600{,}000} \times 100 = 20\%

step 3: liquidity

\text{Current ratio} = \frac{90{,}000}{60{,}000} = 1.5

\text{Acid test} = \frac{90{,}000 - 30{,}000}{60{,}000} = \frac{60{,}000}{60{,}000} = 1.0

step 4: interpret

A $40\%$ gross and $15\%$ operating margin and a $20\%$ ROCE show solid profitability and efficient use of capital. A current ratio of $1.5$ and an acid test of $1.0$ show the firm can comfortably meet its short-term debts. The figures are most meaningful compared with last year and with rivals.

Value and limitations of ratio analysis

Ratios make large accounts interpretable and comparable: they let a firm track performance over time, benchmark against rivals, and guide decisions. But they have limitations: they use historic data that may not predict the future, they ignore qualitative factors (staff, brand, market conditions), accounting policies can distort comparisons, and a single ratio out of context can mislead. The rule is to read several ratios together, over time and against a benchmark, and to combine them with judgement.

Examples in context

A retailer compares its gross margin with last year to check pricing and buying. A bank checks a borrower's gearing and current ratio before lending. An investor uses ROCE to compare two firms' efficiency. A manufacturer's falling acid test warns it may struggle to pay suppliers, prompting action on cash.

Try this

Q1. A firm has current assets of $\pounds 120{,}000$ and current liabilities of $\pounds 60{,}000$ . Calculate the current ratio. [2 marks]

Cue. $\tfrac{120{,}000}{60{,}000} = 2$ (or $2{:}1$ ).

Q2. A firm has operating profit of $\pounds 150{,}000$ and capital employed of $\pounds 1{,}000{,}000$ . Calculate the ROCE. [2 marks]

Cue. $\tfrac{150{,}000}{1{,}000{,}000} \times 100 = 15\%$ .

Exam-style practice questions

Practice questions written in the style of WJEC Eduqas exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

Eduqas 20206 marksA firm has revenue of

\pounds 600{,}000

, gross profit of

\pounds 240{,}000

and operating profit of

\pounds 90{,}000

. Calculate the gross profit margin and the operating profit margin. (6)

Show worked answer →

A Component 2 calculation rewarding both formulae, working and percentages.

Gross profit margin $= \tfrac{\text{gross profit}}{\text{revenue}} \times 100 = \tfrac{240{,}000}{600{,}000} \times 100 = 40\%$ .

Operating profit margin $= \tfrac{\text{operating profit}}{\text{revenue}} \times 100 = \tfrac{90{,}000}{600{,}000} \times 100 = 15\%$ .

Markers reward both correct margins with the percentage sign. A strong answer notes the gap between the two (40% to 15%) reflects operating expenses such as wages and overheads. The common error is to divide profit by costs rather than by revenue.

Eduqas 202210 marksEvaluate the usefulness of ratio analysis for judging the performance of a business. (10)

Show worked answer →

A levels-of-response evaluation. For: ratios turn raw figures into comparable measures of profitability, liquidity and gearing, let a firm track performance over time and benchmark against rivals or industry norms, and guide decisions (a falling current ratio warns of a liquidity problem; a rising ROCE shows assets used better); they make large accounts interpretable. Against: ratios are based on past, historic data that may not predict the future, they ignore qualitative factors (staff morale, brand, market conditions), accounting policies can distort comparisons, and a single ratio out of context can mislead. Evaluation: ratio analysis is a valuable tool for judging performance, but only when several ratios are read together, compared over time and against benchmarks, and combined with qualitative judgement; it informs rather than decides. The top band judges and applies.

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Sources & how we know this

Eduqas A Level Business Specification (A510) — Eduqas (2015)