CH12Mindmap

Tap any card to reveal its definition

πŸ“„ Financial Statements β€” Key Terms
Income Statement
Gross Profit
Sales minus cost of sales / direct cost of manufacturing.
+
Net Profit
Gross profit minus all expenses.
+
Reserves
Retained earnings β€” net profit minus dividends plus previous reserves.
+
Statement of Financial Position
Fixed Assets
Value of long-term assets a business uses or owns β€” e.g. buildings, machinery, vehicles.
+
Current Assets
Value of short-term assets: cash, debtors and closing stock.
+
Current Liabilities
Value of short-term liabilities due within one year: trade creditors and overdraft.
+
Working Capital
Short-term finance available to run the business day to day.
Formula: Current Assets βˆ’ Current Liabilities
+
Debt Capital
Long-term borrowing β€” bank loans over 5 years and preference shares.
+
Equity Capital
Long-term funding from owners β€” issued share capital plus reserves.
+
Capital Employed
All long-term funding for the business.
Formula: Equity Capital + Debt Capital
+
πŸ“ˆ Profitability Ratios
Gross Profit Margin (GPM)
GPM β€” Formula
(Gross Profit Γ· Sales) Γ— 100 = x.xx%
Measures: percentage of sales kept after deducting cost of sales.
+
GPM β€” Improve It
Increase sales (e.g. advertising campaign) or reduce direct costs (e.g. source cheaper suppliers).
+
GPM β€” Stakeholders
Employees (job security); Investors (measure performance against competitors).
+
Net Profit Margin (NPM)
NPM β€” Formula
(Net Profit Γ· Sales) Γ— 100 = x.xx%
Measures: percentage of sales kept after deducting all expenses.
+
NPM β€” Improve It
Increase sales; reduce expenses (e.g. switch to a cheaper service provider).
+
NPM β€” Stakeholders
Employees (job security); Investors (compare return against competitors).
+
Return on Investment (ROI)
ROI β€” Formula
(Net Profit Γ· Capital Employed) Γ— 100 = x.xx%
Capital Employed = Equity Capital + Debt Capital.
Measures: percentage return on all long-term capital invested.
+
ROI β€” Improve It
Increase net profit (reduce expenses or increase sales); reduce debt capital.
+
ROI β€” Stakeholders
Investors β€” shows their expected return; easier to attract investors if ROI improves. Employees with shares.
+
πŸ’§ Liquidity Ratios
Current Ratio β€” Ideal 2:1
Current Ratio β€” Formula
Current Assets : Current Liabilities = x.xx:1
Ideal: 2:1. Compares value of all current assets to all current liabilities.
+
Current Ratio β€” Improve It
Budget better to build up cash reserves; reduce short-term liabilities.
+
Current Ratio β€” Stakeholders
Suppliers β€” shows the risk of the business becoming a bad debt.
+
Acid Test Ratio β€” Ideal 1:1
Acid Test β€” Formula
(Current Assets βˆ’ Closing Stock) : Current Liabilities = x.xx:1
Ideal: 1:1. Removes stock as it can be slow to convert to cash.
+
Acid Test β€” Improve It
Sell slow-moving stock at a discount to convert it to cash quickly.
+
Acid Test β€” Stakeholders
Suppliers β€” shows whether the business can pay short-term debts without relying on selling stock.
+
βš–οΈ Gearing β€” Debt/Equity Ratio
Debt/Equity β€” Formula
Debt Capital : Equity Capital = x.xx:1
<1:1 = low geared. 1:1 = neutral. >1:1 = highly geared (more debt than equity).
+
Debt/Equity β€” Stakeholders
Shareholders β€” high debt means high interest repayments which reduces the profit available for dividends.
+
Limitations of Ratio Analysis
Does not account for: staff turnover; overvalued assets; competitor context; economic variables that affect results.
+

Tap card to flip Β· βœ“ removes from deck Β· βœ— goes to bottom

Tap to reveal
2021 Short Q8 Calculate ROI for Stylish Tile & Bath Ltd + analyse the change. (10) β–Ό
Stylish Tile & Bath Ltd: Net Profit €72,000 | Issued Ordinary Share Capital €450,000 | Long-Term Loan €100,000 | Retained Earnings €26,000 | ROI 2019 = 7%
(i) Calculate ROI for 2020. Show your formula and workings. (6 marks)
(ii) Analyse the significance of the change in ROI. (4 marks β€” 2+2)
✏️ Part (i) β€” ROI Calculation
Formula: (Net Profit Γ· Capital Employed) Γ— 100 Capital Employed = €450,000 + €100,000 + €26,000 = €576,000 ROI = (72,000 Γ· 576,000) Γ— 100 = 12.5%
✏️ Part (ii) β€” Significance of the Change
Easier to attract investors: The ROI has increased from 7% to 12.5%. Potential investors are more likely to provide capital when they see a strong return β€” making it easier for Stylish Tile & Bath Ltd to raise equity capital if needed.
Potential to fund expansion: As ROI improves, the business builds stronger capital reserves and is more likely to be approved for additional finance to fund growth.
πŸ“Œ MS: (i) 6m β€” formula (1m) + capital employed figures (3m) + answer (1m) + % sign (1m). (ii) 4m (2+2). Always state whether the ratio has improved or worsened and by how much, then explain the significance for a named stakeholder.
2017 Q6(B) Calculate four ratios for Equinox Design Ltd. (20) β–Ό
Sales €200,000 | Net Profit €30,400 | Current Assets €20,000 | Current Liabilities €16,000 | Issued Share Capital €300,000 | Long-Term Loan €400,000 | Retained Earnings €60,000
Calculate: (i) NPM (ii) Current Ratio (iii) ROI (iv) Debt/Equity Ratio. Show your workings. (20 marks)
✏️ Four Calculations β€” formula β†’ figures β†’ answer
(i) NPM = (Net Profit Γ· Sales) Γ— 100 = (30,400 Γ· 200,000) Γ— 100 = 15.2% (ii) Current Ratio = Current Assets : Current Liabilities = 20,000 : 16,000 = 1.25:1 (iii) Capital Employed = 300,000 + 400,000 + 60,000 = 760,000 ROI = (30,400 Γ· 760,000) Γ— 100 = 4% (iv) Debt/Equity = Debt Capital : Equity Capital = 400,000 : (300,000 + 60,000) = 400,000 : 360,000 = 1.1:1
πŸ“Œ MS: Each ratio = formula (1m) + figures (1–3m) + answer (1–2m). Always show workings β€” marks are awarded at each step. Answers must be in the correct format: % for profitability ratios; x.xx:1 for all other ratios. Two decimal places required.
2017 Q6(C) Analyse profitability and liquidity vs 2015 + should Equinox expand? + limitations. (25) β–Ό
2015 results: NPM 20.5% | Current Ratio 2:1 | ROI 8% | Debt/Equity 0.7:1
(i) Analyse the profitability and liquidity of Equinox Design Ltd for 2016 with reference to 2015.
(ii) Should Equinox expand? Give one reason.
(iii) Outline two limitations of ratio analysis.
✏️ Part (i) β€” Profitability Analysis
NPM has worsened β€” fallen from 20.5% (2015) to 15.2% (2016). This means Equinox Design is keeping less of each euro of sales as net profit after expenses, which is a concern for investors and employees as it indicates rising costs or falling sales.
ROI has worsened β€” fallen from 8% (2015) to 4% (2016). Investors are earning a significantly lower return on their capital, making it harder for Equinox to attract new investment or fund expansion.
✏️ Part (i) β€” Liquidity Analysis
Current Ratio has worsened β€” fallen from 2:1 (2015, the ideal) to 1.25:1 (2016). The business is less able to cover its short-term debts from current assets β€” suppliers may view this as an increased bad debt risk.
✏️ Part (ii) β€” Should Equinox Expand?
No β€” the business should not expand. The Debt/Equity ratio has worsened from 0.7:1 to 1.1:1 β€” Equinox is now highly geared (more debt than equity). Taking on additional borrowing to fund expansion would increase interest repayments further, reducing already-falling profits.
✏️ Part (iii) β€” Two Limitations
Competitor context: Ratios do not show how the business compares to industry competitors β€” a ratio that appears weak may actually be above the industry average.
Overvalued assets: If fixed assets are overvalued on the balance sheet, Capital Employed will be inflated β€” distorting the ROI calculation and giving a misleading picture of performance.
πŸ“Œ For trend analysis: always state whether the ratio has improved or worsened, by how much, and the significance for a named stakeholder. The structure is: trend β†’ direction β†’ impact on stakeholder.
2022 Q7(A) Explain Debt/Equity ratio + calculate for two years + comment on trend. (25) β–Ό
(i) Explain the term Debt/Equity Ratio. (5 marks β€” 2+3)
(ii) Calculate the Debt/Equity Ratio for 2021 and 2020. (12 marks)
(iii) Comment on whether the ratio has improved or disimproved. (5 marks β€” 2+3)
✏️ Part (i) β€” Explain
Debt/Equity Ratio: Compares the long-term funding of the business β€” the percentage funded by debt versus the percentage funded by equity. A ratio below 1:1 = low geared; 1:1 = neutral; above 1:1 = highly geared (more debt than equity).
✏️ Part (ii) β€” Format for Calculation
Debt/Equity = Debt Capital : Equity Capital Debt Capital = Long-term loans + preference shares Equity Capital = Issued share capital + reserves Formula (1m) β†’ Figures (1m each) β†’ Answer (2m)
✏️ Part (iii) β€” Comment on Trend
State whether the ratio has improved or worsened (e.g. "increased from 0.7:1 to 1.1:1 β€” worsened"). Then explain the significance: a higher ratio means the business is more highly geared β€” higher interest repayments reduce the profit available for shareholder dividends, and the business is more exposed to interest rate increases.
πŸ“Œ MS: 5m (2+3) + 3m formula + 2 Γ— 6m (2+1+1+2) + 5m (2+3). For the trend comment, always name the stakeholder affected (shareholders) and explain the specific impact β€” not just "it got better/worse."
2023 Short Q7 Explain liquidity + calculate Acid Test Ratio. (10) β–Ό
(a) Explain the term liquidity. (b) Calculate the Acid Test Ratio for the following: Current Assets €80,000 | Closing Stock €20,000 | Current Liabilities €40,000.
✏️ Part (a) β€” Liquidity
Liquidity: The ability of a business to pay its short-term debts as they fall due, using its current assets. A liquid business has sufficient short-term assets to cover its short-term liabilities.
✏️ Part (b) β€” Acid Test Calculation
Formula: (Current Assets βˆ’ Closing Stock) : Current Liabilities = (80,000 βˆ’ 20,000) : 40,000 = 60,000 : 40,000 = 1.5:1
πŸ“Œ The Acid Test removes closing stock because stock can be slow to convert to cash β€” it gives a stricter view of short-term liquidity. A result of 1.5:1 is above the ideal of 1:1, so this business is in a good liquidity position. Always express the answer as x.xx:1 to two decimal places.
The following topics are identified as 2026 must-knows for Chapter 12: Ratio Analysis based on past paper frequency and the 2026 trend master sheet.
Long ratio question β€” calculate all ratios + analyse trends for stakeholders Hot
Listed as a 2026 must-know. The classic format: calculate 3–4 ratios from given figures, compare to the previous year, state whether each has improved or worsened, explain the significance for a named stakeholder. Past papers: 2017 Q6(B+C), 2019 Q5(B), 2014 Q5(B), 2010 Q5(B+C). Always show formula β†’ figures β†’ answer in that order.
ROI / Profitability ratio β€” short question calculation Hot
Listed as a 2026 must-know. ROI appears as a short question almost every year β€” 2021 SQ8, 2016 SQ5, 2011 SQ2. Know the formula precisely: (Net Profit Γ· Capital Employed) Γ— 100. Capital Employed = Equity + Debt (share capital + reserves + long-term loans). Past papers: 2021 SQ8, 2016 SQ5, 2011 SQ2.
Debt/Equity ratio β€” explain, calculate and comment Watch
Appeared in 2025 SQ7, 2022 Q7(A), 2016 SQ5, 2014 Q5(B), 2009 Q5(C). Know the gearing terminology: below 1:1 = low geared; above 1:1 = highly geared. Know the significance for shareholders β€” high gearing means high interest repayments reducing dividends. Past papers: 2025 SQ7, 2022 Q7(A), 2014 Q5(B).
Liquidity ratios β€” acid test calculation and explain Watch
Acid test appeared in 2023 SQ7. Current ratio in 2013 SQ3. Know both formulas and why the acid test removes stock (slow to convert to cash). Know the ideal ratios: Current Ratio 2:1; Acid Test 1:1. Know suppliers are the key stakeholder interested in liquidity ratios. Past papers: 2023 SQ7, 2019 Q5(B), 2013 SQ3, 2007 Q6(C).
Calculation
Formula β†’ Figures β†’ Answer
Always present ratio calculations in this exact order: write the formula, substitute the figures, then give the answer. Marks are awarded at each step β€” showing workings is essential. Answers must be in the correct format: % for profitability ratios; x.xx:1 for liquidity and gearing. Two decimal places required.
ROI: (Net Profit Γ· Capital Employed) Γ— 100 = (72,000 Γ· 576,000) Γ— 100 = 12.5%
Capital Employed
Add all three components
Capital Employed = Equity Capital + Debt Capital = Issued Share Capital + Reserves + Long-Term Loans. All three must be added together. The most common error in ROI calculations is missing one of the three components β€” usually forgetting to include Retained Earnings.
Capital Employed: Share Capital €450,000 + Retained Earnings €26,000 + Long-Term Loan €100,000 = €576,000
Trend Analysis
Trend β†’ Impact β†’ Stakeholder
For trend analysis questions: (1) state the direction β€” improved or worsened and by how much, (2) explain the impact on the business, (3) name the stakeholder most affected and explain why they care. Never just say "it got better" β€” always say better for whom and why.
"The ROI has improved from 7% to 12.5%. This will make it easier for Stylish Tile & Bath Ltd to attract investors, as the return on their capital has increased significantly."