WACE Business — Unit 4
Financial Ratios — Flashcards & Quiz
Financial ratios turn raw accounting numbers into meaningful measures of performance and risk. WACE Business Unit 4 expects you to calculate and interpret liquidity, profitability, efficiency and gearing ratios, compare them to benchmarks, and use them to justify business decisions. Strong answers go beyond the number to tell the story: what changed, why, and what management should do.
Key Points
- Liquidity: current ratio = CA/CL, quick ratio excludes inventory. Healthy current ratio ~2:1.
- Profitability: gross margin = GP/sales; net margin = NPAT/sales; ROE = NPAT/equity.
- Efficiency: inventory turnover, debtor days, asset turnover.
- Gearing: D/E ratio. Higher gearing = higher risk but can boost ROE.
- Compare to industry benchmarks and prior years — single-number analysis is meaningless.
- Trend analysis over 3-5 years reveals direction, not just snapshot.
Common Mistakes to Avoid
- Calculating correctly but failing to interpret — markers want analysis.
- Comparing ratios across industries without noting different benchmarks.
- Confusing gross and net profit margin.
- Assuming a high current ratio is always good — it may signal idle working capital.
- Ignoring the reason behind a ratio change.
Exam Strategy
WACE Unit 4 ratio questions typically give financial statements and ask for calculation, interpretation and recommendation. Method: (1) calculate with workings, (2) compare to benchmark and trend, (3) explain the story, (4) evaluate stakeholder implications, (5) recommend specific actions. Always link the number back to a business decision.
Sample Flashcards
Q1: Explain the key profitability ratios and what they measure.
Gross profit margin = (Gross Profit / Revenue) x 100 — measures production efficiency and pricing effectiveness. Net profit margin = (Net Profit / Revenue) x 100 — measures overall profitability after all expenses. Return on equity (ROE) = (Net Profit / Owner's Equity) x 100 — measures how effectively the business uses owner investment to generate profit.
Q2: What are liquidity ratios and why are they important?
Liquidity ratios measure a business's ability to meet short-term financial obligations. Current ratio = Current Assets / Current Liabilities — ideally 1.5:1 to 2:1. Quick ratio (acid test) = (Current Assets - Inventory) / Current Liabilities — a stricter test excluding inventory, ideally above 1:1. Low ratios indicate potential difficulty paying debts; excessively high ratios suggest capital is not being used productively.
Q3: Explain efficiency ratios and their importance in operations management.
Efficiency ratios measure how effectively a business uses its resources. Inventory turnover = COGS / Average Inventory — how many times inventory is sold per year; higher is better. Accounts receivable days = (Receivables / Revenue) x 365 — average days to collect payment; lower is better. Asset turnover = Revenue / Total Assets — revenue generated per dollar of assets; higher indicates better asset utilisation.
Q4: What is the debt-to-equity ratio and what does it indicate?
Debt-to-equity ratio = Total Liabilities / Owner's Equity. It measures the proportion of debt versus equity used to finance the business. A ratio above 1:1 means more debt than equity (higher financial risk). A lower ratio indicates more conservative financing. The ideal ratio varies by industry — capital-intensive industries like mining typically carry higher debt.
Sample Quiz Questions
Q1: A current ratio of 0.5:1 indicates the business can easily meet its short-term obligations.
Answer: FALSE
A current ratio below 1:1 means current liabilities exceed current assets — the business may struggle to pay short-term debts. The ideal range is 1.5:1 to 2:1.
Q2: The quick ratio excludes inventory from current assets because inventory may not be easily converted to cash.
Answer: TRUE
The quick (acid test) ratio excludes inventory because it may take time to sell and may need to be discounted. It provides a stricter test of short-term liquidity.
Q3: A high inventory turnover ratio always indicates strong business performance.
Answer: FALSE
While high inventory turnover generally indicates efficient stock management, excessively high turnover may indicate stockouts and lost sales due to insufficient inventory.
Revision Tip
Ratio formulas and interpretation rules are recurring exam recall — drill them with Revizi then rehearse interpreting statement changes under time pressure.
Last updated: March 2026 · 4 flashcards · 4 quiz questions