AccountingRevision - Master A-Level Accounting with AI

Evaluating Performance — Internal and External Comparisons

Ratio analysis covers four areas:

Area	Key ratios	What it shows
Profitability	Gross profit %, net profit %, ROCE	Ability to generate profit from sales and capital
Liquidity	Current ratio, acid test ratio	Ability to meet short-term obligations
Efficiency	Inventory days, receivable days, payable days, asset turnover	How well resources are managed
Capital structure / gearing	Gearing ratio, interest cover	Proportion of debt finance and ability to service it

Compare to industry averages or to a named competitor
Identifies whether the business is outperforming or underperforming its sector
Limited by differences in accounting policies, business size, and market segment

Historical — based on past data; may not predict the future
Accounting policies differ — depreciation methods, inventory valuation, and provisions vary; ratios of different companies may not be comparable even under the same standards
Window dressing — ratios at the year-end may not reflect the typical position throughout the year
Non-financial factors ignored — ratios say nothing about product quality, customer satisfaction, staff morale, or environmental impact
Single ratios mislead — must consider multiple ratios together and in context
Inflation — distorts year-on-year comparisons if prices have changed significantly