Financial Statement Analysis: Key Ratios Every Accountant Should Understand
By James Mante · Accounting & Finance Professional
Financial statements become more useful when we can explain what the numbers mean. Ratios help accountants identify trends, ask better questions and communicate risks to decision-makers.
Fictional business example
Consider a fictional UK trading business with the following figures for one year. All amounts are illustrative.
| Financial information | GBP |
|---|---|
| Revenue | £240,000 |
| Cost of sales | £156,000 |
| Gross profit | £84,000 |
| Net profit | £24,000 |
| Current assets | £72,000 |
| Inventory | £18,000 |
| Current liabilities | £48,000 |
| Average trade receivables | £30,000 |
| Annual credit sales | £180,000 |
1. Gross profit margin
Formula: Gross profit ÷ revenue × 100.
Calculation: £84,000 ÷ £240,000 × 100 = 35%.
For each £1 of sales, the business retains 35p after direct costs of sales. Compare this with prior periods, budget and comparable businesses; a decline may indicate cost increases, pricing pressure or product mix changes.
2. Net profit margin
Formula: Net profit ÷ revenue × 100.
Calculation: £24,000 ÷ £240,000 × 100 = 10%.
This measures overall profit after the expenses included in the reported net profit figure. A good analysis should check which costs and accounting policies are included before comparing companies.
3. Current ratio
Formula: Current assets ÷ current liabilities.
Calculation: £72,000 ÷ £48,000 = 1.50:1.
The business has £1.50 of current assets for each £1 of current liabilities. That does not guarantee it can pay its bills on time: some assets may be slow to convert into cash.
4. Quick ratio
Formula: (Current assets − inventory) ÷ current liabilities.
Calculation: (£72,000 − £18,000) ÷ £48,000 = 1.125:1 (approximately 1.13:1).
Removing inventory provides a more conservative liquidity view, especially when stock takes time to sell. Other illiquid current assets may also need consideration depending on the analysis.
5. Trade receivables days (debtor days)
Formula: Average trade receivables ÷ annual credit sales × 365.
Calculation: £30,000 ÷ £180,000 × 365 = 60.8 days (approximately 61 days).
On average, the business has the equivalent of around 61 days of credit sales outstanding. Compare that with customer payment terms and receivables ageing; the ratio alone cannot identify overdue accounts.
How an accountant should interpret the results
These measures are most useful together. A business may report healthy profits but experience cash pressure because customers take too long to pay. Similarly, a strong current ratio may conceal inventory that is difficult to sell.
A recruiter or finance manager should expect more than formula memorisation: explain the trend, investigate underlying transactions, consider business context and recommend appropriate actions.
Practical follow-up questions
- Are gross margins changing because of pricing, purchase costs or stock losses?
- Does the net margin reflect one-off items?
- How much of current assets is actually available to settle liabilities?
- Which customers account for the oldest unpaid invoices?
- Do monthly cash forecasts support the liquidity ratios?
Educational note: All amounts and the business are fictional. Ratios vary by industry, seasonality and accounting policies; they should not be interpreted in isolation. Debtor days uses average receivables and credit sales, which is important for comparability.