A-Level Business · Y12 + Y13 · 2026 Edition
Financial Ratios
Masterclass.
The complete teaching pack for ratio analysis. Profitability, liquidity, gearing and efficiency, every formula worked on one firm from start to finish, plus how to interpret each ratio, what good looks like, practice questions with mark schemes, and the mistakes that cost marks.
AQA 7132 · 3.5
Edexcel 9BS0 · 3.5
OCR H431
How to use this pack
Pages 2–5: Teach the three families of ratios. Every formula is worked on the same firm so students see one full picture, not nine disconnected sums.
Page 6: Interpretation, benchmarks and limitations, the AO3 / AO4 skill where the marks actually are.
Pages 7–8: Practice questions with mark schemes, and the top mistakes that turn a correct calculation into a lost mark.
Foundation
Three families, one firm
Every ratio answers a different question about a business. Group them into three families first, then work them all on a single set of accounts so students see how they connect.
Edexcel 3.5AQA 3.5OCR finance
Profitability
"How well does it turn sales and capital into profit?"
- Gross profit margin
- Operating profit margin
- ROCE
Liquidity
"Can it pay its short-term bills?"
- Current ratio
- Acid test (quick ratio)
Gearing & efficiency
"How is it financed, and how well does it manage assets?"
- Gearing
- Inventory turnover
- Receivables & payables days
The worked firm — Northgate Retail Ltd (illustrative)
One set of figures, used for every ratio in this pack, so students follow one story rather than nine unrelated sums.
| Income statement (year) | £ | Balance sheet (extract) | £ |
|---|
| Revenue | 2,000,000 | Current assets | 600,000 |
| Cost of sales | 1,200,000 | of which inventory | 250,000 |
| Gross profit | 800,000 | of which receivables | 200,000 |
| Operating expenses | 500,000 | Current liabilities | 400,000 |
| Operating profit | 300,000 | of which payables | 150,000 |
| | Non-current liabilities | 600,000 |
| | Capital employed | 1,500,000 |
The golden rule of ratio analysis
A ratio means nothing on its own
A current ratio of 1.5 is neither good nor bad until you compare it: to last year (trend), to a competitor, or to an industry norm. Examiners reward students who interpret a ratio in context, not those who just state the number. Calculation is half the marks; the judgement is the other half.
Family 1 of 3
Profitability ratios
How efficiently the business converts sales into profit, and how well it uses the capital invested in it. All worked on Northgate Retail Ltd.
Worked — Northgate
(£800,000 ÷ £2,000,000) × 100
Gross profit margin= 40%
Worked — Northgate
(£300,000 ÷ £2,000,000) × 100
Operating profit margin= 15%
Worked — Northgate
(£300,000 ÷ £1,500,000) × 100
ROCE= 20%
Examiner's eye
Compare the two margins to find the story
Northgate keeps 40% gross but only 15% operating: the gap is its overheads. If gross margin holds but operating margin falls year on year, the problem is rising operating costs, not pricing or buying. Spotting which margin moved is a Level-4 analytical point.
Family 2 of 3
Liquidity ratios
Whether the business can pay its short-term debts as they fall due. A profitable firm can still fail if it runs out of cash, which is why liquidity is examined so heavily.
Worked — Northgate
£600,000 ÷ £400,000
Current ratio= 1.5 : 1
Worked — Northgate
(£600,000 − £250,000) ÷ £400,000 = £350,000 ÷ £400,000
Acid test= 0.88 : 1
Examiner's eye
A "healthy" current ratio can hide a liquidity problem
Northgate looks fine at 1.5:1, but its acid test of 0.88:1 shows that without selling inventory it cannot cover its short-term debts. For a retailer holding lots of stock this may be normal; for a service firm it would be alarming. Always read the two liquidity ratios together, and in the context of the sector.
Family 3 of 3
Gearing & efficiency ratios
How the business is financed (debt vs equity), and how well it manages stock, customers and suppliers. All worked on Northgate Retail Ltd.
Worked — Northgate
(£600,000 ÷ £1,500,000) × 100
Gearing= 40%
Worked — Northgate
(£250,000 ÷ £1,200,000) × 365
Inventory turnover≈ 76 days
Worked — Northgate
Receivables: (£200,000 ÷ £2,000,000) × 365 ≈ 37 days
Payables: (£150,000 ÷ £1,200,000) × 365 ≈ 46 days
Working-capital cycle insightPays suppliers (46d) after collecting from customers (37d) = healthy
The link students miss
Efficiency days drive liquidity
If Northgate let receivables days drift to 70 while payables stayed at 46, cash would leave faster than it arrives, and the acid test would worsen. The efficiency ratios explain WHY the liquidity ratios moved. Connecting the two is exactly the analysis examiners reward.
Where the marks live
Interpreting ratios — the AO3 / AO4 skill
Any student can put numbers into a formula. The marks are in what the number means for this business, in this context, and what the firm should do about it.
What "good" looks like (broad benchmarks)
ROCE
higher is better
Compare to interest rates: a ROCE below what the bank pays signals weak returns.
Current ratio
~1.5 to 2.0 : 1
Too low risks insolvency; too high may mean idle cash or excess stock.
Acid test
~1 : 1 (sector-dependent)
Below 1 is normal for stock-heavy retail, riskier for service firms.
Gearing
below ~50%
High gearing means more interest and more risk if rates rise or sales fall.
1. Trend beats snapshot
One year is a photo; three years is a story. Always say which direction the ratio is moving and what is driving it.
2. Context decides "good"
A 0.8 acid test is fine for a supermarket, dangerous for a consultancy. Judge against the sector, not a universal rule.
3. Ratios connect
Falling margins, rising receivables days and a weakening acid test are one story, not three. Link them.
The limitations to always mention (AO4)
Why ratios are never the whole answer
Ratios are historic (they describe the past), quantitative only (they ignore brand, staff, market conditions), and only as reliable as the accounts. A strong evaluation uses the ratio AND names what it cannot see, then judges the decision on balance.
Calculate, then interpret
Practice questions + mark schemes
Worked on a second firm, Harbour Foods Ltd. Calculation marks plus the interpretation marks where the grade is decided.
Q1 · Profitability4 marks
Calculate Harbour Foods' ROCE.
Operating profit £180,000 · Capital employed £1,200,000
Mark scheme: (180,000 ÷ 1,200,000) × 100 (2 marks method) = 15% (2 marks answer). OFR applies if method is shown.
Q2 · Liquidity4 marks
Calculate the current ratio and the acid test.
Current assets £450,000 · Inventory £180,000 · Current liabilities £300,000
Mark scheme: Current ratio = 450,000 ÷ 300,000 = 1.5:1 (2). Acid test = (450,000 − 180,000) ÷ 300,000 = 270,000 ÷ 300,000 = 0.9:1 (2).
Q3 · Interpret9 marks
Harbour Foods' gearing has risen from 35% to 58% in two years while ROCE has fallen from 18% to 15%. Analyse what this suggests about the business.
Indicative content: rising gearing = more debt, more interest, more risk (AO1/AO2). Falling ROCE means returns are dropping while borrowing rises, so new debt is not generating proportionate returns (AO3). Develop: vulnerable if interest rates rise or sales fall; may struggle to service debt. Top answers note it depends on what the debt funded (e.g. expansion not yet yielding returns) and recommend monitoring before judging. 9 marks: detailed analysis in context, sustained reasoning, justified conclusion.
From examiner reports
The mistakes that cost marks
A correct calculation can still score badly. These are the recurring traps in ratio questions.
1
Stating the number, then stopping
"ROCE is 20%." So what? No interpretation = no AO3 marks. Always say what it means for the firm.
2
No comparison
A ratio with nothing to compare it to (trend, competitor, sector) cannot be judged. Always benchmark.
3
Confusing the margins
Gross uses gross profit; operating uses operating profit. Mixing them collapses the answer.
4
Forgetting × 100 on percentages
Margins, ROCE and gearing are percentages. A decimal like 0.2 is not the answer; 20% is.
5
Treating ratios as the whole picture
Ratios are historic and quantitative only. An evaluation that ignores their limits caps at Level 3.
6
Ignoring the sector
"Good" depends on the industry. The same acid test can be safe for a retailer and dangerous for a service firm.
How to use this pack
Teach the formula, then drill the interpretation
Use the worked firm (pages 2–5) to teach each formula, then spend most of your time on page 6: interpretation is where the marks are and where students are weakest. Set the practice questions (page 7) as a timed task, mark for the "so what", and use the mistakes list as a self-check before any ratio assessment.
Built for A-Level Business — AQA 7132 (3.5), Edexcel 9BS0 (3.5) and OCR H431 finance content. Ratio formulae follow the standard A-Level definitions; some ratios have more than one accepted form, so always use your board's preferred formula. Company figures (Northgate Retail Ltd, Harbour Foods Ltd) are illustrative and written for teaching.
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