AQA A-Level Accounting: Analysis and evaluation of financial information (7127) – Revision Notes

Condensed recall notes for section 3.8, Analysis and evaluation of financial information, of the AQA A-level Accounting (7127) specification (version 1.1, October 2026, for A-level exams from June 2019 onwards). The qualification is not tiered, and the specification lists section 8 in the content assessed by both Paper 1 and Paper 2. For full explanations and a worked set of accounts, use the study guide.

Then test yourself with the practice questions. See also the AQA A-level Accounting hub, the 7127 checklist, the earlier notes on preparing sole trader statements and the free diagnostics.

The four outcomes in 3.8

1. Calculate and interpret twelve financial measures and ratios.
2. Appraise performance: profitability, liquidity, efficiency, capital structure.
3. Explain the difference between cash and profits, and the effect of transactions on profitability and liquidity.
4. State the limitations of financial statements and ratio analysis, both financial and non-financial.

The specification says you must know the ratio formulae.

Formula sheet

Ratio	Formula	Unit
Gross profit margin	GP / Revenue × 100	%
Markup	GP / Cost of sales × 100	%
Profit in relation to revenue	Profit for year (before tax) / Revenue × 100	%
Expenses in relation to revenue	Expenses / Revenue × 100	%
ROCE, sole trader	Profit before interest / (Capital + NCL) × 100	%
ROCE, limited company	Profit from operations / (Equity + NCL) × 100	%
Current ratio	CA / CL	x:1
Liquid capital (acid test) ratio	(CA - Inventory) / CL	x:1
Rate of inventory turnover	Cost of sales / Average inventory	times
Inventory turnover (days)	Average inventory / Cost of sales × 365	days
Trade receivable days	Trade receivables / Credit sales × 365	days
Trade payable days	Trade payables / Credit purchases × 365	days
Capital gearing	NCL / (Issued share capital + Reserves + NCL) × 100	%

NCL = non-current liabilities; CA and CL = current assets and current liabilities. Average inventory = (opening + closing) / 2. For ROCE, opening or closing capital (or equity) may be used. For a sole trader’s gearing, use capital in place of share capital plus reserves.

Useful links between ratios

• Gross margin % - expenses to revenue % = profit to revenue %.
• Margin from markup: margin = markup / (100 + markup) × 100. Markup 25% gives margin 20%.
• Markup from margin: markup = margin / (100 - margin) × 100. Margin 40% gives markup 66.67%.
• Inventory days = 365 / inventory turnover.

What a change usually means

Ratio moves	Possible causes	Why it matters
Gross margin falls	Selling prices cut, discounts, dearer purchases, change in sales mix	Less profit per £ of sales
Expenses to revenue rises	Overheads growing faster than sales, one-off costs	Profit squeezed below gross profit
ROCE falls	Lower profit, or new capital or loans not yet earning	Weaker return on long-term funds
Current ratio rises well above 2:1	Surplus inventory, slow receivables, idle cash	Resources not working
Liquid ratio falls below 1:1	Cash drained, inventory built up	May struggle to pay debts on time
Inventory days rise	Overbuying, slow-moving or obsolete lines	Cash tied up, risk of write-down
Receivable days rise	Weak credit control, longer terms to win sales	Cash arrives later; irrecoverable debt risk
Payable days rise	Using supplier credit, or struggling to pay	Helps cash but may cost discounts or goodwill
Gearing rises	New loan, or equity falling	Higher fixed interest; more risk to owners and lenders

Treat these as possible causes. In an answer, pick the one the data supports and say why.

Method in steps: appraisal answer

1. Calculate the ratios asked for and show the formula with figures.
2. Group them: profitability, liquidity, efficiency, capital structure.
3. Compare each with last year, a competitor or the business’s own target.
4. Give a likely cause from the information in the question.
5. Link groups: for example, longer receivable days explain a lower liquid ratio.
6. Bring in a limitation or a non-financial factor.
7. Finish with a judgement that answers the question set.

Cash versus profit

Item	Profit	Cash
Credit sale	Up when the sale is made	Up only when the customer pays
Depreciation	Down	No effect
Buy non-current asset for cash	No effect now (depreciation later)	Down
Buy inventory for cash	No effect until sold	Down
Loan received	No effect (interest later is an expense)	Up
Loan repaid	No effect	Down
Capital introduced	No effect	Up
Drawings	No effect	Down
Accrued expense	Down	No effect until paid

Key point: a profitable business can run out of cash, and a loss-making one can hold plenty of cash for a while.

Effect of transactions on the current ratio

• When current assets and current liabilities change by the same amount and the ratio is above 1:1, both rising pulls the ratio towards 1:1 and both falling pushes it further above 1:1.
• Swaps within current assets (receivable pays cash) leave the current ratio unchanged.
• Cash spent on inventory leaves the current ratio unchanged but lowers the liquid ratio.
• Selling inventory at a profit raises current assets and both ratios.

Worked reminder. Current assets are £30,000, including inventory of £12,000, and current liabilities are £20,000. The current ratio is 1.50:1 and the liquid ratio is 18,000 / 20,000 = 0.90:1. The business then buys inventory of £4,000 and pays cash. Current assets stay at £30,000, so the current ratio stays at 1.50:1. Inventory rises to £16,000, so the liquid ratio falls to 14,000 / 20,000 = 0.70:1. Profit is unchanged.

Limitations to quote

Financial: historic data; historic cost ignores inflation; different accounting policies; estimates (depreciation, doubtful debts); one year-end date may be untypical or window-dressed; needs a benchmark; missing data such as credit sales.

Non-financial: staff skill and morale; customer satisfaction and reputation; market conditions and competitors; product quality; environmental and social impact; quality of management.

Must-know distinctions

• Margin vs markup: same gross profit, different base (revenue vs cost of sales).
• Profit to revenue vs ROCE: one is per £ of sales; the other is per £ of long-term funds.
• Current vs liquid ratio: the liquid ratio leaves out inventory because it is the least liquid current asset.
• Turnover in times vs days: a higher “times” figure and a lower “days” figure both mean faster-moving inventory.
• Sole trader vs company ROCE: profit before interest with capital, or profit from operations with equity.

Quick self-test

1. Markup is 50%. What is the gross profit margin?
2. Gross profit margin is 20%. What is the markup?
3. Cost of sales £96,000; average inventory £12,000. Find turnover in times and days.
4. CA £45,000 including inventory £15,000; CL £25,000. Find the current and liquid ratios.
5. Trade receivables £18,000; credit sales £146,000. Find receivable days.
6. Share capital £150,000, reserves £60,000, NCL £90,000. Find capital gearing.
7. A company has profit from operations £42,000, equity £250,000 and NCL £100,000. Find ROCE.
8. A trade receivable pays £3,000 by cheque. Effect on the current ratio?
9. A machine is bought for cash. Effect on this year’s profit at the date of purchase?
10. Name two non-financial factors that ratios ignore.
11. Expenses £36,000; revenue £160,000. Find expenses in relation to revenue.
12. A sole trader’s profit for the year is £27,000 after loan interest of £3,000. Capital £120,000; loan £30,000. Find ROCE.

Answers

1. 50 / 150 × 100 = 33.33%
2. 20 / 80 × 100 = 25.00%
3. 96,000 / 12,000 = 8 times; 12,000 / 96,000 × 365 = 45.6 days
4. 45,000 / 25,000 = 1.80:1; 30,000 / 25,000 = 1.20:1
5. 18,000 / 146,000 × 365 = 45.0 days
6. 90,000 / 300,000 × 100 = 30.00%
7. 42,000 / 350,000 × 100 = 12.00%
8. No change: one current asset falls and another rises by the same amount.
9. None at purchase; depreciation reduces profit over the asset’s life. Liquidity falls.
10. Any two: staff morale, customer satisfaction, reputation, market conditions, product quality, environmental impact.
11. 36,000 / 160,000 × 100 = 22.50%
12. (27,000 + 3,000) / 150,000 × 100 = 20.00%

Where marks are usually lost

• Using total revenue for receivable days when credit sales are given.
• Using closing inventory instead of average inventory.
• Writing the current ratio as 1.8 or 180% instead of 1.80:1.
• Leaving loan interest in sole-trader ROCE, so the return is understated.
• Using profit for the year instead of profit from operations in company ROCE.
• Describing a change (“receivable days rose”) with no cause and no consequence.
• Calling a high current ratio “good” without checking what makes it up.
• Saying depreciation reduces cash.
• Listing limitations that have nothing to do with the business in the question.
• Giving no final judgement when the question says evaluate or recommend.

Official syllabus

AQA A-level Accounting (7127) specification, version 1.1, October 2026, for A-level exams June 2019 onwards, published by AQA – section 3.8, Analysis and evaluation of financial information.