How are the main profitability, liquidity and efficiency ratios calculated, and what does each one tell a user about the business?
Calculation and interpretation of accounting ratios covering profitability (gross profit percentage, profit for the year percentage, return on capital employed), liquidity (current ratio, acid test ratio) and efficiency (rate of inventory turnover, trade receivable and trade payable days).
A focused answer to the SQA Higher Accounting ratios content, covering the profitability ratios (gross profit percentage, profit percentage, return on capital employed), the liquidity ratios (current and acid test) and the efficiency ratios (inventory turnover, receivable and payable days), with how each is interpreted.
Reviewed by: AI editorial process; not yet individually human-reviewed
Have a quick question? Jump to the Q&A page
Jump to a section
What this dot point is asking
The SQA wants you to calculate the main accounting ratios from a set of financial statements and interpret what each one reveals about profitability, liquidity or efficiency. At Higher you must do more than produce a figure: you must say what it means, compare it with a benchmark or a previous year, and link several ratios together.
Why ratios matter
A profit of £60,000 tells you little until you know the sales or the capital that produced it. Ratios express one figure in relation to another, so users can judge performance and compare businesses of different sizes. The three families the SQA examines answer three questions: is the business profitable, can it pay its way, and is it using its resources well.
Profitability ratios
A falling gross profit percentage points to higher cost of sales or lower selling prices. A profit percentage well below the gross figure points to heavy expenses. ROCE shows the return earned on the money invested, so it can be compared with what that money could earn elsewhere.
Liquidity ratios
The current ratio checks whether current assets cover current liabilities; a figure around 2:1 is often comfortable, though it varies by industry. The acid test is stricter because inventory, the least liquid current asset, is removed; it tests whether the business could pay its debts without relying on selling stock.
Efficiency ratios
A high rate of inventory turnover means stock sells quickly, tying up less cash. Trade receivable days show how long customers take to pay; fewer days is better for cash flow. Trade payable days show how long the business takes to pay suppliers; this should be managed so the business is not paying faster than it collects.
Try this
Q1. Sales £250,000, gross profit £100,000. Calculate the gross profit percentage. [2 marks]
- Cue. (£100,000 / £250,000) x 100 = 40%.
Q2. Current assets £80,000 (inventory £35,000), current liabilities £40,000. Calculate the acid test ratio. [2 marks]
- Cue. (£80,000 - £35,000) / £40,000 = £45,000 / £40,000 = 1.125:1.
Q3. State what a rising trade receivable days figure suggests. [1 mark]
- Cue. Customers are taking longer to pay, which worsens cash flow and may signal weak credit control.
Exam-style practice questions
Practice questions written in the style of SQA exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.
SQA Higher style6 marksA business has sales of £400,000, gross profit of £160,000, profit for the year of £60,000 and capital employed of £300,000. Current assets are £90,000 (including inventory of £30,000) and current liabilities are £45,000. Calculate the gross profit percentage, the return on capital employed, the current ratio and the acid test ratio.Show worked answer →
Gross profit percentage = (gross profit / sales) x 100 = (£160,000 / £400,000) x 100 = 40% (1 mark).
Return on capital employed = (profit for the year / capital employed) x 100 = (£60,000 / £300,000) x 100 = 20% (2 marks).
Current ratio = current assets / current liabilities = £90,000 / £45,000 = 2:1 (1 mark).
Acid test = (current assets - inventory) / current liabilities = (£90,000 - £30,000) / £45,000 = £60,000 / £45,000 = 1.33:1 (2 marks). Markers reward each ratio with the correct formula and figures.
SQA Higher style4 marksA business has a current ratio of 3:1 but an acid test ratio of 0.8:1. Explain what these two figures together suggest about the business, and state one action it could take.Show worked answer →
The current ratio of 3:1 looks comfortable, suggesting plenty of current assets to cover current liabilities (1 mark).
But the acid test of 0.8:1, below 1:1, shows that once inventory is excluded the business cannot cover its current liabilities from its more liquid assets, so a large part of its current assets is tied up in inventory (2 marks).
One action: reduce inventory levels (for example by selling slow-moving stock) to release cash and improve liquidity, or arrange short-term finance to bridge the gap (1 mark). Markers reward interpreting the gap between the two ratios and a sensible action.
Related dot points
- Interpretation of financial accounting information for different stakeholders, the comparison of performance over time and against other businesses, the reporting of findings with recommendations, and the limitations of accounting information and ratio analysis.
A focused answer to the SQA Higher Accounting interpretation content, covering the information needs of different stakeholders, comparing performance over time and against other businesses, reporting findings with recommendations, and the limitations of accounting information and ratio analysis.
- Preparation of the income statement (trading and profit and loss) and statement of financial position for a sole trader, including adjustments for closing inventory, accruals, prepayments, depreciation, irrecoverable debts and provision for doubtful debts.
A focused answer to the SQA Higher Accounting sole trader final accounts content, covering the income statement and statement of financial position with year-end adjustments for inventory, accruals, prepayments, depreciation, irrecoverable debts and a provision for doubtful debts.
- Preparation of the income statement and statement of financial position for a limited company, including ordinary and preference share capital, share premium, the general reserve, retained earnings, dividends, debentures and the appropriation of profit.
A focused answer to the SQA Higher Accounting limited company content, covering ordinary and preference share capital, share premium, reserves, retained earnings, dividends, debentures, and how a company appropriates profit and presents its equity.
- Overview of the use of spreadsheets to prepare, analyse and present accounting information (formulae, functions and presentation), and the requirements of the course assignment that applies these skills to a practical accounting task.
A focused overview of the SQA Higher Accounting use of spreadsheets and the course assignment, covering spreadsheet formulae and functions, presenting accounting information clearly, and what the assignment asks candidates to do with these skills.
- Preparation of the partnership appropriation account and partners' capital and current accounts, including interest on capital, interest on drawings, partners' salaries and the division of residual profit in the agreed profit-sharing ratio.
A focused answer to the SQA Higher Accounting partnership content, covering the appropriation account, interest on capital and drawings, partners' salaries, sharing residual profit in the agreed ratio, and the difference between fixed capital accounts and fluctuating current accounts.
Sources & how we know this
- SQA Higher Accounting Course Specification — SQA (2023)