O Level Notes : Accounts - Interpretation of financial statements and accounting ratios

This topic is basically about learning the definitions and the formulas of the respective ratios. These ratios and the financial statements you learnt about in the previous chapters can be used to compare 2 or more businesses , let’s say, to decide which one to buy when you’re about to buy a business and are given couple of choices.

Gross margin: gross profit x  100%


Rate of stock turnover:

Cost of sales

Avg stock

Lesser the rate of stock turn over, slower the business would be.



Accounting ratios can only be used if the nature of businesses is the same and the time period of comparison is the same.

Liquidity ratios

Current ratio : the comparison between assets which will become liquid within next 12 months with the liabilities which will be due to be paid within the next 12 months. This ratio is used to find out whether there are sufficient  current assets to meet the liabilities.

Currents assets

Current liabilities


Acid test ratio

Current assets – closing stock

Current liability

No matter how successful a business apparently is, it may fail if it is not sufficiently liquid.


Debtor to sales ratio



The more money is tied up with debtors, the weaker the business would be.

Creditor purchase ratio

Shows how efficient our business is in terms of payment.