Company Accounts and Financial Statement Analysis
This domain tests company equity, dividends, the statement of changes in equity and ratio analysis. Exam questions ask you to prepare extracts or interpret profitability, liquidity, efficiency and gearing ratios.
Core rules
- Share capital is the nominal value issued; share premium is the excess over nominal value.
- Retained earnings accumulate profits less dividends and transfers; dividends are distributions, not expenses.
- The statement of changes in equity reconciles opening equity, profit, other comprehensive income, dividends and closing equity.
- Profitability ratios include gross margin, operating margin and ROCE.
- Liquidity ratios include current ratio and quick ratio.
- Gearing compares debt to equity or capital employed; efficiency includes inventory days and receivables days.
Worked example
Revenue 500,000; gross profit 200,000; operating profit 80,000; profit for the year 60,000; equity 300,000; non-current liabilities 100,000; current liabilities 100,000; current assets 150,000; inventory 50,000. Gross margin = 40%; operating margin = 16%; net margin = 12%. Capital employed = 300,000 + 100,000 = 400,000; ROCE = 80,000 / 400,000 = 20%. Current ratio = 150,000 / 100,000 = 1.5; quick ratio = (150,000 - 50,000) / 100,000 = 1.0.
Traps
- Treating dividends as an expense.
- Using total assets instead of capital employed for ROCE.
- Including inventory in the quick ratio.
- Comparing ratios without checking accounting policies or industry context.