Financial Analysis and Business Economics
Core framework
This domain tests ratio analysis, liquidity, solvency, profitability, turnover, and the economic interpretation of financial statements. Candidates must compute and interpret ratios and understand the drivers of business performance.
Concepts to master
- Liquidity: current ratio (current assets ÷ current liabilities), quick ratio (excluding inventory).
- Solvency and leverage: debt-to-equity, interest coverage.
- Profitability: gross margin, net margin, return on assets, return on equity.
- Turnover/efficiency: inventory turnover, receivables days, asset turnover.
- Business economics: break-even point, contribution margin, operating leverage.
Traps
Questions mix stock (balance-sheet) and flow (income-statement) figures without averaging the balance. Another trap is treating a high current ratio as automatically good - excess inventory can inflate it while signaling poor turnover. Break-even analysis is often confused with cash break-even (which excludes non-cash costs).
Rule of thumb
Match numerator and denominator in time dimension: for return and turnover ratios, use the average balance, not the year-end figure, when the denominator is a balance-sheet item.
Worked example
Current assets 300 (of which inventory 120), current liabilities 150. Current ratio = 300 ÷ 150 = 2.0; quick ratio = (300 − 120) ÷ 150 = 1.2. The gap shows liquidity depends materially on selling inventory.