Calculating ratios is the easy half of an analysis question. The marks, and the usefulness to a reader, come from the other half: saying what the ratios mean, why they moved, what follows for the person who asked, and what should be done.
A list of percentages tells a director nothing; a short report that says “profit has risen but cash is under pressure because inventory and receivables are growing faster than sales, so management should tighten credit” does.
This topic covers how to interpret ratios against the three comparisons in the syllabus, how different stakeholders read the same figures, how to link ratios into a story, the signs of overtrading, and how to set out the answer as a memo or report, using the Zaria Plc figures from the previous topics. The next topic covers earnings per share and cash flow information.
Interpretation and report writing are marked directly. In November Diet, 2023, Question 2 (20 marks) carried 10 marks for a memo to the managing director commenting on performance (marks for the format, subject, comments on the ratios, conclusion and recommendations), and in May Diet, 2026, Question 3 (20 marks) asked for advice to a potential investor on the viability of a company and whether to subscribe to a share issue (4 marks). Read solvency, gearing and investors’ ratios first.
In 30 seconds
Assess performance and position against the prior period, another entity and the industry average. For each area (profitability, efficiency, liquidity, solvency, investors’ returns) say what changed, why, and what it means for the user. Different users focus on different ratios:
- investors on earnings, dividends and growth
- lenders on gearing, interest cover and liquidity
- management on margins and efficiency
- employees and suppliers on survival and liquidity
Link the ratios: a rising margin with falling turnover, or growing sales with falling cash, point to causes. Set out the answer in report or memo format: heading, purpose, findings by area, conclusion, recommendations. For a group, use consolidated figures and compare like with like.
Interpreting the ratios
For every ratio, write three things: the direction (up or down, better or worse than the comparator), the likely cause from other figures in the statements, and the implication for the reader. Compare in this order:
- With the prior period. What has changed and by how much? A trend over several years is stronger than two points.
- With another entity for the same period. Check that the entities are comparable in size, business and accounting policies.
- With the industry average. Shows what is normal. A ratio that is out of line with the sector needs a reason.
For a simple group, interpret the consolidated statements and be careful with ratios affected by the non-controlling interest (include it in capital employed, exclude it from the owners’ return), the profit of associates (not part of operating profit and not backed by cash, only by dividends) and goodwill (which raises capital employed and lowers asset turnover).
When comparing the group with another group, make sure both have the same structure and policies.
Who is reading
- Investors are concerned with return and growth: earnings per share, return on shareholders’ capital, dividend policy and cover, the price-earnings ratio.
- Lenders and bondholders look at the ability to pay interest and repay: gearing, interest cover, liquidity and the cash flow.
- Management monitors margins, expenses, efficiency of working capital and the return against targets.
- Employees are concerned with the survival and profitability of their employer; suppliers with liquidity and the time taken to pay; customers with continuity of supply.
- Regulators and tax authorities look at compliance and the reliability of the figures.
An answer addressed to a particular user should select the ratios that user needs, and say so. A recommendation to an investor, for example, rests on earnings, dividends, growth and risk, while advice to a lender rests on gearing, cover and cash.
Linking the ratios: Zaria Plc
Zaria’s Year 2 sales rose by 20%. Profit before interest and tax rose from ₦160m to ₦180m, but the margin fell from 16.0% to 15.0%, and the return on capital employed from 17.6% to 17.1%. The working capital explains the cash. Receivables rose by 42.9% (₦140m to ₦200m), inventory by 36.4% and payables by 31.3%, all faster than the 20% growth in sales. The cash operating cycle lengthened from 20.7 to 30.4 days.
Non-current assets grew by 18.4%, financed by a new loan, so gearing rose from 27.6% to 31.4% and interest cover fell from 8.0 to 6.0. Cash fell from ₦90m to ₦50m and the quick ratio from 1.19 to 1.00.
Read together: Zaria is growing, profitable and still sound, but it is showing the early signs of overtrading: sales growing quickly while the funds needed for inventory and receivables are drawn from loans, suppliers and cash.
Writing the report or memo
A report is marked for its format and its content. A usable layout:
- Heading: to, from, date and a clear subject (for example, “Performance and position of Zaria Plc for Year 2”).
- Purpose and basis: what was asked, the figures used and the formulas (a short statement; the calculations go in an appendix).
- Findings by area: profitability, efficiency, liquidity, solvency, investors’ returns. Each with the numbers, the comparison and the reason.
- Conclusion: an overall judgement that follows from the findings.
- Recommendations: specific actions, or a decision (for example whether to invest, lend or acquire), with the conditions or further information needed.
- Closing: the signature block of a memo or report.
Write in short paragraphs. Use the numbers, because a comment without a figure earns few marks. Finish with a recommendation that follows from the findings and say what other information, including non-financial information, would be needed to decide.
The ideas in more depth
Why “why” matters more than “what”
Stating that the current ratio fell is description. Saying that it fell because inventory and receivables grew while the cash balance was used for capital expenditure is analysis. The cause points to the remedy.
Why the answer depends on the reader
The same Zaria figures give different advice. To an investor they say: growing earnings and dividends at a P/E of 12. To a lender: moderate gearing and good cover, but cash is falling. To management: watch working capital.
Sources and references
- The Conceptual Framework for Financial Reporting (users and their information needs); the analysis techniques are conventional and not set by a standard.
These points are stated as at 5 November 2026.
Worked examples
Example 1: choosing the ratios. A bank considers lending ₦200m to Zaria. Required: which ratios to emphasise.
- Gearing and cover. Gearing 31.4% and interest cover 6.0 times (falling from 8.0).
- Liquidity and cash. Current ratio 1.60, quick ratio 1.00, cash down from ₦90m to ₦50m.
- Conclusion. Debt service looks comfortable, but the lengthening cycle should be addressed.
Example 2: the story behind falling cash. Sales rose 20%, receivables 42.9% and inventory 36.4%. Required: the explanation.
- Cause. Working capital grew faster than sales, absorbing cash.
- Remedy. Tighten credit and reduce inventory.
Example 3: a recommendation. An investor asks whether to buy shares at ₦6.30. Required: the key points.
- Supporting. earnings per share (EPS) up 7%, dividend cover 2.5, P/E 12.
- Cautions. Margin and return on capital employed (ROCE) slightly down, cash falling.
- Recommendation. A reasonable holding, subject to the sector P/E and to evidence that the margin has stabilised.
How to answer in the exam
- Identify the reader and the decision before you write.
- Use the right format, with a subject line and closing.
- Quote the figures in each comment, and compare.
- End with recommendations, and mention limitations and non-financial information.
Common mistakes in the exam
- Listing ratios without comment.
- Describing the movement but not the cause.
- Writing an essay when a memo or report is asked for.
- Giving advice that does not follow from the figures.
- Ignoring the user’s decision (invest, lend, acquire).
- Comparing with another entity without noting differences in size or policy.
Quick revision
- Compare with the prior period, another entity and the industry.
- Direction, cause, implication for each ratio. Link the ratios.
- Users: investors (returns), lenders (cover, liquidity), management (margins, efficiency).
- Report: heading, purpose, findings, conclusion, recommendations.
Practice questions
These are original questions written in the style of the Institute’s exams. Try each one before you open the answer. Section A is a recall check, because the paper itself is written.
Recall check: multiple choice
Question 1. Interpretation of a ratio means:
- Recalculating it
- Rounding it
- Explaining its direction, cause and implication
- Copying the formula
Show the answer
C. It goes beyond calculation.
Question 2. The three comparisons in analysis are:
- Cost, price and tax
- Prior period, another entity and the industry average
- Budget only
- Assets, liabilities and equity
Show the answer
B. Together they give a ratio meaning.
Question 3. A report should begin with:
- Its purpose and the person it is for
- The calculations only
- The recommendation without explanation
- The audit report
Show the answer
A. The heading, subject and purpose.
Question 4. Overtrading is shown by:
- Falling sales
- Falling borrowing
- Rising liquidity
- Fast sales growth with rising receivables and inventory, falling cash and more borrowing
Show the answer
D. The business is growing faster than its funding.
Question 5. Lenders focus mainly on:
- Dividend yield
- Gearing, interest cover and liquidity
- Price-earnings ratio
- Sales growth only
Show the answer
B. Their concern is repayment.
Question 6. Investors focus mainly on:
- Earnings, dividends, growth and the price-earnings ratio
- Receivables days
- The current ratio
- Tax
Show the answer
A. Their concern is return.
Question 7. A conclusion should be:
- Unrelated to the figures
- A repeat of the formulas
- Supported by the ratios and followed by recommendations
- Omitted
Show the answer
C. It must follow from the findings.
Question 8. Employees are mainly interested in:
- Dividend cover
- Share price
- Gearing only
- The survival and profitability of the employer
Show the answer
D. Job security and pay.
Question 9. In a group analysis, capital employed:
- Excludes goodwill
- Excludes debt
- Includes the non-controlling interest
- Is the parent’s only
Show the answer
C. Because group profit is the whole group’s.
Question 10. Management uses ratios to:
- Monitor performance against targets and past results
- Calculate tax
- Prepare the audit report
- Fix the share price
Show the answer
A. And to decide on action.
Section B style: written questions
Question 11 (10 marks). (a) State the three comparisons used in interpreting ratios. (3 marks) (b) State the ratios that a lender and an investor would each emphasise. (4 marks) (c) State the layout of a memo reporting on performance. (3 marks)
Question 12 (15 marks). A company’s sales grew by 25%. Receivables days rose from 45 to 70, inventory days from 50 to 75, cash fell and short-term borrowing rose. (a) Explain what the figures suggest. (6 marks) (b) State the risk. (4 marks) (c) State THREE recommendations. (5 marks)
A further written question
Question 13 (20 marks). Year 2: revenue ₦1,500m, profit before interest and tax (PBIT) ₦180m, capital employed ₦1,000m, current ratio 1.2, gearing 45%, interest cover 4, receivables days 70. Year 1: revenue ₦1,200m, PBIT ₦170m, capital employed ₦850m, current ratio 1.6, gearing 35%, interest cover 6, receivables days 50. Sector: ROCE 15%, current ratio 1.5, gearing 40%, interest cover 5, receivables days 55.
(a) Calculate the PBIT margin, asset turnover and ROCE for both years. (6 marks) (b) Write a short report to the board comparing the company with its past and the sector. (10 marks) (c) State TWO recommendations. (4 marks)
Model answers
Show the model answer to Question 11
(a) With the prior period (1); with another entity for the same period (1); with the industry average (1).
(b) A lender emphasises gearing, interest cover and liquidity (2). An investor emphasises earnings per share, dividends and cover, return on capital and the price-earnings ratio (2).
(c) Heading with to, from, date and subject (1); purpose and findings by area, with conclusion (1); recommendations and closing (1).
Show the model answer to Question 12
(a) Growth has been financed by slower collection, more inventory and short-term borrowing (2). More cash is tied up in working capital, so cash has fallen (2). These are the signs of overtrading (2).
(b) The company could run out of cash although it is growing and profitable (2), and its short-term borrowing could be withdrawn (2).
(c) Tighten credit control to reduce receivables days (1.5); reduce inventory levels (1.5); fund growth with longer-term finance or new equity (2).
Show the model answer to Question 13
(a)
- Year 2: PBIT margin 180 ÷ 1,500 = 12.0%; turnover 1,500 ÷ 1,000 = 1.5 times; ROCE 18.0%.
- Year 1: margin 170 ÷ 1,200 = 14.2%
- turnover 1,200 ÷ 850 = 1.41 times
- ROCE 170 ÷ 850 = 20.0% (6).
(b) Heading, subject and purpose (2). Profitability: ROCE fell from 20.0% to 18.0%, though above the sector 15%; the margin fell from 14.2% to 12.0% while turnover rose (2). Liquidity: the current ratio fell from 1.6 to 1.2, below the sector 1.5; receivables days rose from 50 to 70, above the sector 55 (2). Solvency: gearing rose from 35% to 45%, above the sector 40%, and interest cover fell from 6 to 4, below the sector 5 (2). Conclusion: growth has been bought with lower margins and more borrowing (2).
(c) Improve credit control to bring receivables days towards 55 (2); control costs to restore the margin and review the funding mix (2).
Pathfinder on Interpreting performance and writing the analysis report
These are the ICAN Pathfinder questions that test this topic. ICAN owns the questions and the suggested solutions, so we point you to them and do not copy them. Open your Pathfinder, attempt each question under exam conditions, then check your answer against the notes above.
Part (b) asks for a memo to the managing director commenting on financial performance using the ratios, with marks for the memo format, subject, comments, conclusion and recommendations (10 marks).
Revise first: Writing the report or memo
Part (b) asks for advice to a potential investor on the viability of the company and whether to subscribe to a share issue (4 marks).
Revise first: Who is reading
Source: ICAN Pathfinder, Financial Reporting. Diets covered: Every diet in the Pathfinder, from November Diet, 2021 to May Diet, 2026, was reviewed here. The diets listed above test this topic directly..
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