A ratio turns two figures from the financial statements into one number you can judge. The skill is choosing the right figures, writing the formula, substituting and giving the answer in the right form.
This lesson follows reading a statement of financial position and prepares you for comparing a ratio across periods. Check your syllabus for which ratios your exam year includes, since 0450 and 0264 may list them differently.
Which formulas should you know?
| Ratio | Formula | Form |
|---|---|---|
| Gross profit margin | gross profit ÷ revenue × 100 | % |
| Profit margin | net profit ÷ revenue × 100 | % |
| ROCE | operating profit ÷ capital employed × 100 | % |
| Current ratio | current assets ÷ current liabilities | ratio, e.g. 1.5:1 |
| Acid test ratio | (current assets − inventory) ÷ current liabilities | ratio, e.g. 1.0:1 |
Operating profit is profit before interest and tax. Some courses and textbooks word the profit used in ROCE slightly differently, so use the definition in your own syllabus and the question.
What is the method?
- Name the ratio and write its formula.
- Find each figure in the statements supplied. Underline the line you take.
- Substitute the numbers into the formula.
- Calculate and round sensibly, usually to one decimal place.
- State the answer with a % sign or in ratio form.
The ratios tool lets you practise this on fictional statements, showing which number is the numerator and which is the denominator.
Worked example
Tiara Printing Sdn Bhd, a print shop in Penang, has these figures for the year (ignore tax).
| Item | RM |
|---|---|
| Revenue | 400,000 |
| Cost of sales | 260,000 |
| Operating profit | 40,000 |
| Interest paid | 5,000 |
| Current assets (including inventory of 30,000) | 90,000 |
| Current liabilities | 60,000 |
| Capital employed | 250,000 |
Gross profit = 400,000 − 260,000 = 140,000. Gross profit margin = 140,000 ÷ 400,000 × 100 = 35%.
Net profit = operating profit − interest = 40,000 − 5,000 = 35,000. Profit margin = 35,000 ÷ 400,000 × 100 = 8.75%.
ROCE = 40,000 ÷ 250,000 × 100 = 16%.
Current ratio = 90,000 ÷ 60,000 = 1.5:1.
Acid test ratio = (90,000 − 30,000) ÷ 60,000 = 60,000 ÷ 60,000 = 1.0:1.
Every calculation has the formula, the substitution and the answer. That layout also makes it easy to spot if you used the wrong figure.
The mistake to watch for
A common slip is leaving inventory in the acid test.
Mistaken answer: acid test ratio = 90,000 ÷ 60,000 = 1.5:1.
The student calculated the current ratio and called it the acid test.
The acid test excludes inventory because stock may take time to sell.
The correction is to subtract inventory from current assets first, then divide. A second slip to watch is using gross profit in the margin for the whole business. Profit margin uses net profit.
Check yourself
1. A shop has revenue of RM150,000 and gross profit of RM60,000. Find the gross profit margin.
Show answer
60,000 ÷ 150,000 × 100 = 40%.
2. A workshop has current assets of RM54,000, inventory of RM18,000 and current liabilities of RM36,000. Find the current ratio and the acid test ratio.
Show answer
Current ratio = 54,000 ÷ 36,000 = 1.5:1. Acid test = (54,000 − 18,000) ÷ 36,000 = 36,000 ÷ 36,000 = 1.0:1.
3. A business has operating profit of RM21,000 and capital employed of RM175,000. Find ROCE.
Show answer
21,000 ÷ 175,000 × 100 = 12%.
Where this leads next
A single ratio is only a number. Comparing a ratio across periods with context shows how to turn it into a judgement.
If you often have the formulas right and the figures wrong, that is a habit a teacher can see quickly in your written working. Our online one-to-one Business tuition includes that kind of close reading, and the cash versus profit bridge is a useful companion for the cash side of the story.