A firm has current assets of 240,000 and current liabilities of 160,000. Calculate the current ratio. [2 marks]

EnglandBusinessSyllabus dot point

How do businesses measure profitability and financial health?

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

A focused answer to the OCR A-Level Business finance theme on statements and ratios, covering the income statement and statement of financial position, profitability ratios (gross and operating margin, ROCE), liquidity ratios (current and acid test), the gearing ratio, and the value and limits of ratio analysis.

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, then operating profit, then profit for the year). The statement of financial position (balance sheet) shows assets, liabilities and equity at a point in time. Profitability ratios: gross margin $= \tfrac{\text{gross profit}}{\text{revenue}} \times 100$ , operating 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 $= \tfrac{\text{non-current liabilities}}{\text{capital employed}} \times 100$ . Ratios are powerful for comparison but historical and need a benchmark.

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

What this theme is asking

OCR wants you to read the two main financial statements and to calculate and interpret profitability, liquidity and gearing ratios, then judge the value and limits of ratio analysis. This is the most calculation-heavy part of the finance theme and a staple of Components 2 and 3.

The financial statements

The two statements answer different questions: the income statement asks "did the firm make a profit?"; the balance sheet asks "is the firm financially healthy and solvent?". Ratios draw figures from both.

Profitability ratios

The gross margin shows the profit left after the direct cost of making the product. The operating margin shows the profit left after overheads too, so the gap between the two reflects running costs. Return on capital employed (ROCE) is the headline measure of efficiency: how much operating profit the firm generates for every pound of capital invested (where $\text{capital employed} = \text{equity} + \text{non-current liabilities}$ ). A higher ROCE means capital is being used more productively.

Liquidity ratios

The acid test matters most for firms holding large, slow-moving stock; for a supermarket with fast-moving stock and little credit, a lower current ratio is normal and not a worry.

Gearing

Worked example: profitability, liquidity and gearing

A firm reports revenue $\pounds 800{,}000$ , operating profit $\pounds 120{,}000$ , current assets $\pounds 300{,}000$ (of which inventory $\pounds 120{,}000$ ), current liabilities $\pounds 200{,}000$ , non-current liabilities $\pounds 250{,}000$ and equity $\pounds 250{,}000$ .

step 1: operating margin

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

step 2: ROCE

Capital employed $= 250{,}000 + 250{,}000 = \pounds 500{,}000$ , so:

\text{ROCE} = \frac{120{,}000}{500{,}000} \times 100 = 24\%

step 3: current and acid-test ratios

\text{Current ratio} = \frac{300{,}000}{200{,}000} = 1.5 \qquad \text{Acid test} = \frac{300{,}000 - 120{,}000}{200{,}000} = 0.9

step 4: gearing and interpretation

\text{Gearing} = \frac{250{,}000}{500{,}000} \times 100 = 50\%

The firm is reasonably profitable (

24\%

ROCE), with a healthy current ratio (

1.5

) but a tighter acid test (

0.9

, suggesting it leans on stock to cover short-term debts), and is on the borderline of high gearing (

50\%

), so further borrowing should be cautious if cash flows are volatile.

Value and limitations

Ratios turn complex accounts into comparable figures and aid comparison over time and against rivals. But they rely on past data (they describe the past, not the future), ignore qualitative factors (brand, staff, management, market outlook), can be distorted by one-off events or different accounting policies, and only mean something against a benchmark, the firm's own history or an industry norm.

Examples in context

A bank assessing a loan looks at gearing and liquidity to judge default risk. Next has historically combined efficient working capital with moderate gearing, which analysts cite as a reason for its resilience. Thomas Cook, before its 2019 collapse, carried very high gearing and weak liquidity; the ratios warned of fragility well before failure. A supermarket runs a low current ratio safely because its stock sells fast and it pays suppliers more slowly than it collects from customers.

Try this

Q1. A firm has current assets of $\pounds 240{,}000$ and current liabilities of $\pounds 160{,}000$ . Calculate the current ratio. [2 marks]

Cue. $\tfrac{240{,}000}{160{,}000} = 1.5$ .

Q2. Analyse why a bank would look at a firm's gearing ratio before lending. [6 marks]

Cue. High gearing means high existing interest commitments, so further lending raises default risk in a downturn, developed as a chain in context.

Exam-style practice questions

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

OCR H431/02 20196 marksA firm has revenue of

\pounds 800{,}000

, gross profit of

\pounds 320{,}000

and operating profit of

\pounds 120{,}000

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

Show worked answer →

A Component 2 calculation rewarding both formulae, working and units. Gross profit margin $= \tfrac{\text{gross profit}}{\text{revenue}} \times 100 = \tfrac{320{,}000}{800{,}000} \times 100 = 40\%$ . Operating profit margin $= \tfrac{\text{operating profit}}{\text{revenue}} \times 100 = \tfrac{120{,}000}{800{,}000} \times 100 = 15\%$ . Markers reward both margins and the percentage signs. A strong answer comments: the gap between the two (40% to 15%) reflects operating expenses (overheads), so the firm keeps 40p of gross profit per pound of sales but only 15p after running costs. The common error is to divide by profit rather than by revenue.

OCR H431/02 202416 marksEvaluate the value of ratio analysis to a bank deciding whether to lend to a UK manufacturer. (16)

Show worked answer →

A 16-mark evaluation on a four-level grid. For: ratios let the bank judge the firm's profitability (margins, ROCE), its liquidity (current and acid test ratios show whether it can meet short-term debts), and its gearing (how heavily it is already borrowed, and therefore the risk of more debt). Chain: high gearing means high existing interest commitments, so a further loan raises the risk of default in a downturn, which the gearing ratio reveals. Against: ratios are historical (they describe the past, not the future), can be distorted by one-off events or accounting choices, ignore qualitative factors (management, order book, market outlook), and mean little without a benchmark. Evaluation: ratios are a powerful first screen for a lender but must be trended, benchmarked and combined with qualitative due diligence. A judged conclusion reaches the top band.

Related dot points

Sources & how we know this

OCR A-Level Business (H431) specification — OCR (2015)