Analysis and interpretation (i): common size and performance ratios

A set of financial statements is a page of numbers. By itself it says little. Is a profit of ₦50,000 good? On sales of ₦150,000 it is very good. On sales of ₦5 million it is weak. Analysis turns numbers into judgements by comparing them: with last year, with a target, with a competitor, and with each other.

This topic covers who uses the statements and what they want, common size analysis (vertical and horizontal), rebasing for inflation, return on capital employed (ROCE), return on shareholder capital (ROSC), margins, asset turnover and the working capital ratios. The next topic covers liquidity, debt and investor ratios, the limits of ratios and exam technique. November 2025 Question 3 and May 2026 Question 2 were reports on ratios.

Key terms in plain English

Syllabus check

Analysis and interpretation is examinable under syllabus area C. This topic covers:

• common size, horizontal and trend analysis, and rebasing for inflation;
• profitability, asset turnover and working capital ratios, linked to what drives them.

CAMA 2020 and analysis

The Companies and Allied Matters Act 2020 (CAMA 2020) requires statements that follow International Financial Reporting Standards (IFRS) and give a true and fair view.

Users and what they want

Management is not on the list because it has more detailed internal information. In the exam, the question names the user. Pick ratios that help that user decide.

Common size analysis

In the statement of profit or loss the base is revenue. In the statement of financial position the base is total assets. Vertical analysis compares lines within a year (and across years or companies). Horizontal analysis shows the percentage change in each line. Together they show what moved and by how much.

Rebasing for inflation

Nominal growth can mislead when prices rise fast. Restate the earlier year in the later year’s prices (multiply by one plus the inflation rate) and then find the growth.

Return on capital

• ROCE = profit before interest and tax ÷ capital employed × 100. Capital employed = share capital and reserves + long-term debt (use the average of opening and closing if possible). For a group, include the NCI in capital employed. A large overdraft that is rolled over can be treated as capital employed, with its interest included above the line.
• ROSC = profit after tax ÷ shareholders’ capital × 100. For a group, use the parent’s shareholders’ capital without the NCI.
• Return on assets = profit before interest and tax ÷ total assets.

Management usually looks at ROCE and an equity investor at ROSC, so calculate the one the user cares about. Compare either one with the return available elsewhere (for example bond yields), remembering that those are market returns and ROCE is an accounting return. ROCE and ROSC can be managed through the choice of lease, revaluation and the timing of purchases and finance.

Margins and asset turnover

• Gross profit margin = gross profit ÷ revenue. Net profit margin = profit after tax ÷ revenue. Operating margin = profit before interest and tax ÷ revenue. Be consistent in the definition from year to year.
• Look at cost ratios too: cost of sales, administration and distribution as a percentage of revenue. A high gross margin with a low net margin means high overheads.
• Asset turnover = revenue ÷ capital employed (in times). Growth in revenue = (this year − last year) ÷ last year.

The link between them

ROCE = profit margin × asset turnover. A fall in ROCE comes from a lower margin (price or cost problem), a lower asset turnover (more assets or capital for the same sales), or both. This is the first step in explaining any change.

Working capital efficiency

• Receivables days = receivables ÷ credit sales (or revenue) × 365.
• Inventory days = inventory ÷ cost of sales × 365.
• Payables days = payables ÷ cost of purchases (or cost of sales) × 365.
• Cash cycle = inventory days + receivables days − payables days.

Use average balances where you can, and the closing balances if the question gives only those. Too long a cycle means too much money tied up and a lower ROCE. Too short a cycle (with low working capital) may mean the company is relying on suppliers and its overdraft and is close to a liquidity problem. Watch for seasonal year ends, which distort the balances.

The rules in more depth

Why compare

A ratio on its own says nothing. It needs a benchmark: last year, the budget, the industry or a competitor.

Why a ratio does not give the cause

A fall in margin can come from price cuts, dearer materials, wage rises, a currency change or a change in the product mix. The ratio flags it. Management then finds the reason.

Why averages are better

Year-end balances can be unusually high or low. An average of the opening and closing balances is closer to the position through the year.

Effect on analysis

The best answers link movements: for example, higher inventory days, a lower cash balance and a higher overdraft tell one story.

Worked examples

1. Gross profit: 1,000,000 (66.7%) and 900,000 (56.3%). Net profit: 300,000 (20.0%) and 140,000 (8.8%).
2. Cost of sales rose from 33.3% to 43.8% of revenue. Distribution rose from 26.7% to 28.1%; administration fell from 20.0% to 19.4%.
3. The fall in gross margin is the main reason for the fall in net margin from 20.0% to 8.8%.

1. Revenue +6.7%; cost of sales +40.0%; gross profit −10.0%; distribution +12.5%; administration +3.3%; net profit −53.3%.
2. Costs grew far faster than revenue, so profit halved.

1. Vertical (Year 2): non-current assets 60.2%; inventory 18.1%; receivables 12.0%; cash 9.6%; equity 33.7%; non-current liabilities 30.1%; current liabilities 36.1%.
2. Horizontal: non-current assets +25%; inventory +50%; receivables −50%; cash −20%; equity −20%.
3. Comment: assets were expanded and funded by more debt and more current liabilities. Inventory is building up. Cash is falling. Equity fell by ₦700,000, which points to a loss or a large dividend.

1. Nominal growth = 20%.
2. 20X4 in 20X5 prices = 1,000,000 × 1.15 = 1,150,000.
   Real growth = 1,200,000 ÷ 1,150,000 − 1 = 4.3%.

1. Profit before interest and tax.
   210,000 + 30,000 = 240,000.
2. Capital employed: opening 1,000,000; closing 1,400,000; average 1,200,000.
   ROCE = 240,000 ÷ 1,200,000 = 20%.
3. Shareholders’ capital: 800,000 and 900,000; average 850,000.
   ROSC = 145,000 ÷ 850,000 = 17.06%.

1. Profit margin before interest and tax.
   240,000 ÷ 5,800,000 = 4.14%.
   Net margin = 145,000 ÷ 5,800,000 = 2.5%.
2. Asset turnover.
   5,800,000 ÷ 1,200,000 = 4.83 times.
3. Check.
   4.14% × 4.83 = 20%, the ROCE.
4. Growth.
   if the previous year’s sales were ₦5,500,000, growth = 300,000 ÷ 5,500,000 = 5.45%.

1. Averages: inventory 330,000; receivables 435,000; payables 165,000.
2. Receivables days.
   435,000 ÷ 3,000,000 × 365 = 52.9.
3. Inventory days.
   330,000 ÷ 1,800,000 × 365 = 66.9.
4. Payables days.
   165,000 ÷ 1,800,000 × 365 = 33.5.
5. Cash cycle.
   66.9 + 52.9 − 33.5 = 86.3 days.

1. Inventory days.
   250,000 ÷ 1,000,000 × 365 = 91.
2. Receivables days.
   400,000 ÷ 1,200,000 × 365 = 122.
3. Payables days.
   166,667 ÷ 1,000,000 × 365 = 61.
4. Cash cycle.
   91 + 122 − 61 = 152 days.

How to score full marks

• Name the user and choose ratios that fit them.
• Show each formula and the numbers used. Do not just write the answer.
• Be selective. A few ratios with good comments score more than many without.
• Explain every change with a likely cause and a consequence.
• Link ratios (for example margin, turnover and ROCE; inventory days and cash).
• Use the facts in the question and the company’s name.
• Say what extra information you would want.

Common mistakes in the exam

• Using profit after interest for ROCE.
• Using profit before tax as operating profit without adding back interest.
• Leaving the NCI out of the capital employed of a group.
• Using revenue for inventory and payables days.
• Listing numbers without a reason for the change.
• Mixing definitions of a ratio between years.
• Ignoring inflation when comparing years.

Quick revision

• Vertical: percentage of revenue or total assets. Horizontal: percentage change.
• ROCE = PBIT ÷ capital employed. ROSC = profit after tax ÷ shareholders’ capital.
• ROCE = margin × asset turnover.
• Receivables and payables days use revenue and cost of sales; cash cycle = inventory + receivables − payables.
• Rebase for inflation before comparing growth.
• CAMA 2020: ss. 377(1), 378, 379 to 381, 374(1), 385, 404(7).

Practice questions

These are original questions written in the style of the Institute of Chartered Accountants of Nigeria (ICAN) exam. Try each one before you open the answer. Full model answers follow the written questions.

Recall check: multiple choice

The real ICAN paper has no multiple-choice section. These questions are for quick recall. The written questions that follow are closer to the exam.

Written questions

Model answers

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