Gross profit 30000, sales 120000. Find the gross profit percentage. [2 marks]

Current assets 16000, current liabilities 8000. Find the current ratio. [1 mark]

Cost of goods sold 36000, average inventory 6000. Find the rate of inventory turnover. [2 marks]

ScotlandAccountingSyllabus dot point

How do you calculate and interpret the main accounting ratios for profitability, liquidity and efficiency?

Calculating and interpreting profitability ratios (gross profit percentage, profit for the year percentage), liquidity ratios (current ratio, acid test) and the efficiency ratio rate of inventory turnover.

A focused answer to the SQA National 5 Accounting content on ratio analysis, covering the gross profit percentage and profit for the year percentage, the current ratio and acid test ratio for liquidity, the rate of inventory turnover for efficiency, and how to interpret each ratio to judge business performance.

Generated by Claude Opus 4.811 min answerUpdated 2026-06-15

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

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Quick answer

Ratios turn the financial statements into comparable measures. Profitability: gross profit percentage $= \dfrac{\text{gross profit}}{\text{sales}} \times 100$ and profit for the year percentage $= \dfrac{\text{profit for the year}}{\text{sales}} \times 100$ . Liquidity: current ratio $= \dfrac{\text{current assets}}{\text{current liabilities}}$ (ideal about $2:1$ ) and acid test $= \dfrac{\text{current assets} - \text{inventory}}{\text{current liabilities}}$ (ideal about $1:1$ ). Efficiency: rate of inventory turnover $= \dfrac{\text{cost of goods sold}}{\text{average inventory}}$ . Always state what each result means.

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What this dot point is asking
Why use ratios?
Profitability ratios
Liquidity ratios
Efficiency: rate of inventory turnover
Interpreting ratios
Examples in context
Try this

What this dot point is asking

The SQA wants you to calculate and interpret the main accounting ratios: profitability (gross profit percentage, profit for the year percentage), liquidity (current ratio, acid test ratio) and efficiency (rate of inventory turnover). Interpretation - saying what the ratio means - matters as much as the calculation.

Why use ratios?

A profit of $\pounds 12000$ tells you little on its own - is that good for the size of the business? Ratios put figures in proportion so you can compare one year with another or one business with another. The SQA groups them into profitability (how well the firm makes profit), liquidity (whether it can pay short-term debts) and efficiency (how well it uses its resources).

Profitability ratios

Calculate the profitability ratios

A business reports sales of $\pounds 100000$ , a gross profit of $\pounds 45000$ , and a profit for the year of $\pounds 18000$ .

Step 1: Calculate the gross profit percentage

The gross profit percentage measures how much of every pound of sales is kept as trading profit before expenses. Divide gross profit by sales and multiply by 100:

\text{Gross profit \%} = \dfrac{45000}{100000} \times 100 = 45\%

Step 2: Calculate the profit for the year percentage

This ratio shows how much of every pound of sales survives after all running costs are paid. The denominator is still sales, not gross profit:

\text{Profit for the year \%} = \dfrac{18000}{100000} \times 100 = 18\%

Step 3: Interpret the gap

The difference between the two percentages, $45\% - 18\% = 27\%$ , is the share of sales consumed by expenses. In other words, 27 pence in every pound of sales went on running costs such as wages, rent and insurance.

Final answer: Gross profit percentage $45\%$ ; profit for the year percentage $18\%$ .

Liquidity ratios

Liquidity ratios test whether the business can pay its debts due within a year.

Calculate the liquidity ratios

A business has current assets of $\pounds 24000$ (including inventory of $\pounds 9000$ ) and current liabilities of $\pounds 12000$ .

Step 1: Calculate the current ratio

The current ratio divides all current assets by current liabilities. It shows whether the business could, in principle, pay all its short-term debts if it converted every current asset to cash:

\text{Current ratio} = \dfrac{24000}{12000} = 2:1

A result of $2:1$ is close to the ideal, meaning the business holds twice as many current assets as short-term debts.

Step 2: Remove inventory and calculate the acid test ratio

Inventory is the hardest current asset to convert to cash quickly, so the acid test strips it out. This gives a stricter test of immediate liquidity:

\text{Acid test} = \dfrac{24000 - 9000}{12000} = \dfrac{15000}{12000} = 1.25:1

Step 3: Interpret

At $1.25:1$ , the acid test is above the ideal of $1:1$ , so the firm can cover its short-term debts from liquid assets alone, without needing to sell stock.

Final answer: Current ratio $2:1$ ; acid test ratio $1.25:1$ .

Efficiency: rate of inventory turnover

The rate of inventory turnover shows how many times a business sells and replaces its average inventory in a year. A higher rate usually means stock is selling quickly and cash is not tied up.

Calculate the rate of inventory turnover

A business has opening inventory of $\pounds 4000$ , closing inventory of $\pounds 6000$ , and cost of goods sold of $\pounds 40000$ .

Step 1: Find the average inventory

The formula requires the average of opening and closing inventory, because holding level changes over the year. Using just one figure would give a misleading picture:

\text{Average inventory} = \dfrac{4000 + 6000}{2} = \pounds 5000

Step 2: Divide cost of goods sold by average inventory

Cost of goods sold (not sales) is used because inventory is held at cost, and comparing like with like gives a meaningful rate:

\text{Rate of inventory turnover} = \dfrac{40000}{5000} = 8 \text{ times a year}

Step 3: Interpret the result

Turning over stock eight times a year means the business sells and replaces its average holding roughly once every six to seven weeks. A higher rate generally indicates stock is selling quickly and cash is not tied up in slow-moving goods.

Final answer: Rate of inventory turnover $= 8$ times a year.

Interpreting ratios

A number alone earns little; the SQA wants a comment. A rising gross profit percentage suggests a better margin or higher selling prices; a falling one may signal discounting or rising supplier costs. A current ratio well below $2:1$ may mean liquidity problems; well above may mean cash sitting idle. Always link the figure back to the business.

Examples in context

Two shops both make $\pounds 20000$ profit, but one has sales of $\pounds 100000$ (a $20\%$ profit for the year percentage) and the other $\pounds 200000$ (just $10\%$ ): the first controls its costs far better. A bank checks the current ratio and acid test before lending, and a supplier watching a customer's falling inventory turnover may worry that stock is not selling. Turning the statements into ratios, then explaining what they reveal, is exactly what this dot point tests.

Try this

Q1. Gross profit $\pounds 30000$ , sales $\pounds 120000$ . Find the gross profit percentage. [2 marks]

Cue. $\dfrac{30000}{120000} \times 100 = 25\%$ .

Q2. Current assets $\pounds 16000$ , current liabilities $\pounds 8000$ . Find the current ratio. [1 mark]

Cue. $16000 \div 8000 = 2:1$ .

Q3. Cost of goods sold $\pounds 36000$ , average inventory $\pounds 6000$ . Find the rate of inventory turnover. [2 marks]

Cue. $36000 \div 6000 = 6$ times a year.

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 N5 style4 marksA business has sales of 80000 pounds, cost of goods sold of 48000 pounds and profit for the year of 12000 pounds. Calculate the gross profit percentage and the profit for the year percentage.

Show worked answer →

Gross profit $=$ sales $-$ cost of goods sold $= 80000 - 48000 = \pounds 32000$ (1 mark). Gross profit percentage $= \dfrac{\text{gross profit}}{\text{sales}} \times 100 = \dfrac{32000}{80000} \times 100 = 40\%$ (1 mark). Profit for the year percentage $= \dfrac{\text{profit for the year}}{\text{sales}} \times 100 = \dfrac{12000}{80000} \times 100 = 15\%$ (1 mark for method, 1 mark for the answer). Markers reward using sales as the denominator in both ratios and the two correct percentages.

SQA N5 style4 marksA business has current assets of 18000 pounds (including inventory of 6000 pounds) and current liabilities of 9000 pounds. Calculate the current ratio and the acid test ratio, and comment on the firm's liquidity.

Show worked answer →

Current ratio $= \dfrac{\text{current assets}}{\text{current liabilities}} = \dfrac{18000}{9000} = 2:1$ (1 mark). Acid test ratio $= \dfrac{\text{current assets} - \text{inventory}}{\text{current liabilities}} = \dfrac{18000 - 6000}{9000} = \dfrac{12000}{9000} = 1.33:1$ (1 mark). The current ratio of $2:1$ is close to the ideal, and the acid test above $1:1$ means the firm can meet short-term debts even without selling inventory, so liquidity is healthy (1 mark for an interpretation, 1 mark for both ratios correct). Markers reward removing inventory in the acid test and a comment that links the figures to the ability to pay short-term debts.

Related dot points

Sources & how we know this

National 5 Accounting Course Specification — SQA (2023)
National 5 Accounting formulae sheet — SQA (2022)