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

This guide covers 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. The specification lists section 8 in the content assessed by both Paper 1 and Paper 2, each a 3-hour written exam, and you must use a calculator in the exam.

Use it with the revision notes and the practice questions. The ratios are worked from statements like those in preparation of financial statements of sole traders, and the users who read them are introduced in the role of the accountant. See also the AQA A-level Accounting hub, the 7127 checklist and the free diagnostics. All businesses and figures are invented.

What section 3.8 covers

Specification content (3.8)	What you must be able to do
Calculation and interpretation of financial measures and ratios	Calculate and interpret gross profit margin %, markup %, rate of inventory turnover (times and days), profit in relation to revenue %, expenses in relation to revenue %, return on capital employed %, current ratio, liquid capital ratio, trade receivable days, trade payable days and capital gearing
Appraising business performance using financial statements and ratios	Judge profitability, liquidity, efficiency and capital structure
The difference between cash and profits	Explain why they differ and the effect of transactions on profitability and liquidity
The limitations of financial statements and ratio analysis	Cover both financial and non-financial factors

The specification’s appendix of accounting ratios says you will be required to know the formulae, so learn them. Section 3.17 later adds investors’ ratios for limited companies; they are not part of 3.8.

The formulae

These follow the wording of the specification’s appendix.

Group	Ratio	Formula
Profitability	Gross profit margin	Gross profit / Revenue × 100
Profitability	Markup	Gross profit / Cost of sales × 100
Profitability	Profit in relation to revenue	Profit for year (before tax) / Revenue × 100
Profitability	Expenses in relation to revenue	Expenses / Revenue × 100
Profitability	ROCE (sole trader)	Profit before interest / Capital employed × 100, where capital employed = capital + non-current liabilities
Profitability	ROCE (limited company)	Profit from operations / Capital employed × 100, where capital employed = equity + non-current liabilities
Liquidity	Current ratio	Current assets / Current liabilities, expressed as x:1
Liquidity	Liquid capital (acid test) ratio	(Current assets - inventory) / Current liabilities, expressed as x:1
Efficiency	Rate of inventory turnover	Cost of sales / Average inventory
Efficiency	Rate of inventory turnover (days)	Average inventory / Cost of sales × 365
Efficiency	Trade receivable days	Trade receivables / Credit sales × 365
Efficiency	Trade payable days	Trade payables / Credit purchases × 365
Capital structure	Capital gearing	Non-current liabilities / (Issued share capital + Reserves + Non-current liabilities) × 100

Average inventory is normally (opening + closing) / 2. For ROCE, the specification allows either opening or closing capital (or equity); say which one you used. The gearing formula is written for a company. For a sole trader, capital takes the place of share capital plus reserves, so the denominator is the same capital employed figure used for ROCE.

Worked example: Ashby Garden Supplies

Ashby Garden Supplies is a sole trader. Extracts for the year ended 31 December 2025:

Income statement	£
Revenue (credit sales £360,000; cash sales £120,000)	480,000
Opening inventory	32,000
Purchases (all on credit)	308,000
Closing inventory	40,000
Cost of sales	300,000
Gross profit	180,000
Expenses (include loan interest £4,000 and depreciation £12,000)	132,000
Profit for the year	48,000

Statement of financial position at 31 December 2025	£
Non-current assets	220,000
Inventory 40,000; trade receivables 36,000; bank 4,000	80,000 current assets
Trade payables 38,000; other payables 2,000	40,000 current liabilities
Non-current liability: bank loan	50,000
Capital (opening 196,000 + profit 48,000 - drawings 34,000)	210,000

Check: 220,000 + 80,000 - 40,000 - 50,000 = 210,000, so the statement balances.

Profitability

Gross profit margin = 180,000 / 480,000 × 100 = 37.50%
Markup              = 180,000 / 300,000 × 100 = 60.00%
Profit to revenue   =  48,000 / 480,000 × 100 = 10.00%
Expenses to revenue = 132,000 / 480,000 × 100 = 27.50%
ROCE = (48,000 + 4,000) / (210,000 + 50,000) × 100
     = 52,000 / 260,000 × 100 = 20.00%  (closing capital)

Interest is added back because ROCE measures the return on all long-term funds, including the loan. Notice that gross margin minus expenses to revenue gives profit to revenue: 37.5 - 27.5 = 10.

Liquidity

Current ratio       = 80,000 / 40,000 = 2.00:1
Liquid capital ratio = (80,000 - 40,000) / 40,000 = 1.00:1

Efficiency

Average inventory = (32,000 + 40,000) / 2 = 36,000
Inventory turnover = 300,000 / 36,000 = 8.33 times
Inventory days     = 36,000 / 300,000 × 365 = 43.8 days
Receivable days    = 36,000 / 360,000 × 365 = 36.5 days
Payable days       = 38,000 / 308,000 × 365 = 45.0 days

Use credit sales, not total revenue, for receivable days: cash sales never create a receivable.

Capital structure

Capital gearing = 50,000 / (210,000 + 50,000) × 100 = 19.23%

Appraising performance

A ratio means little on its own. The specification asks you to appraise profitability, liquidity, efficiency and capital structure, so compare with the previous year (or a competitor) and explain causes. Ashby’s 2024 ratios, from the same accounting policies:

Ratio	2024	2025
Gross profit margin	40.00%	37.50%
Markup	66.67%	60.00%
Profit to revenue	12.00%	10.00%
Expenses to revenue	28.00%	27.50%
ROCE	23.58%	20.00%
Current ratio	2.19:1	2.00:1
Liquid capital ratio	1.32:1	1.00:1
Inventory days	40.6	43.8
Receivable days	30.0	36.5
Payable days	46.6	45.0
Capital gearing	20.33%	19.23%

Revenue rose from £450,000 to £480,000 (6.67%), but the appraisal reads like this:

• Profitability. Gross margin fell 2.5 percentage points. Possible causes: price cuts to win the extra sales, or dearer purchases not passed on. Expenses were controlled (27.5% against 28.0%), so the fall in profit to revenue comes from trading, not overheads. ROCE fell to 20.00%. That is still well above the 8% Ashby pays on its loan (£4,000 on £50,000), but the trend is down.
• Liquidity. Both ratios are still at or above 1:1, but the liquid ratio dropped by about a quarter. Bank is only £4,000. Ashby can meet current debts only if customers pay on time.
• Efficiency. Inventory is held about three days longer and customers take six and a half days longer to pay. Both tie up cash. Ashby pays suppliers in about 45 days, so it still collects before it pays, but the gap has narrowed sharply.
• Capital structure. Gearing below 20% is low. The loan is not a threat, and Ashby has room to borrow if it needs to.

A sound conclusion: sales growth has been bought with lower margins and looser credit control, and the owner should tighten collection before liquidity becomes a problem.

Cash and profit are different

Profit is income earned less expenses incurred, measured under the accruals concept. Cash is money actually received and paid. They differ because:

• credit sales and credit purchases are counted before the cash moves;
• depreciation reduces profit but involves no cash;
• buying inventory uses cash but only cost of sales reaches the income statement;
• buying non-current assets uses cash but only depreciation hits profit;
• loans received or repaid, capital introduced and drawings move cash but are not income or expenses.

Worked example: why Ashby’s bank fell

Ashby’s bank went from £19,000 to £4,000 despite a profit of £48,000. During 2025 it bought equipment for £30,000. Opening trade receivables were £30,000 and opening trade payables £35,000.

Profit for the year                       48,000
Add depreciation (not a cash expense)     12,000
Less increase in inventory (40 - 32)      (8,000)
Less increase in receivables (36 - 30)    (6,000)
Add increase in trade payables (38 - 35)   3,000
Less drawings                            (34,000)
Less equipment bought                    (30,000)
Change in bank                           (15,000)

19,000 - 15,000 = £4,000, which agrees with the statement of financial position.

Effect of transactions on profitability and liquidity

Start from Ashby’s current assets £80,000 (inventory £40,000) and current liabilities £40,000. Treat each transaction separately.

Transaction	Profit	Current ratio	Liquid ratio
Pay a trade payable £10,000 from the bank	No effect	70/30 = 2.33:1 (rises)	30/30 = 1.00:1 (no change)
Buy inventory £6,000 on credit	No effect	86/46 = 1.87:1 (falls)	40/46 = 0.87:1 (falls)
Sell goods costing £3,000 for £5,000 cash	+£2,000	82/40 = 2.05:1 (rises)	45/40 = 1.13:1 (rises)
Charge depreciation	Falls	No effect	No effect
Buy a non-current asset for cash	No immediate effect	Falls	Falls
Owner takes cash drawings	No effect	Falls	Falls

The first row is a useful trap: cash falls, yet the current ratio improves, because a ratio above 1:1 rises when equal amounts leave both sides.

Limitations of financial statements and ratio analysis

The specification says limitations include both financial and non-financial factors.

Financial limitations

• Statements are historic. They show last year, not next year.
• Historic cost ignores inflation, so asset values and ROCE can mislead.
• Different policies (depreciation method, provision for doubtful debts) make comparisons between businesses unreliable.
• A year-end figure may not be typical. Seasonal trade, or paying suppliers just before the year end, changes the liquidity ratios.
• Some figures are estimates, such as depreciation and doubtful debts.
• Ratios need a benchmark. Without last year or a competitor, a ratio cannot be judged.
• Information may be missing. For example, credit sales may not be given separately.

Non-financial limitations

• Statements do not show staff skill, morale or turnover.
• Customer satisfaction, reputation and brand strength are not measured.
• They say nothing about market conditions, competitors or new technology.
• Product quality and environmental or social impact are left out.
• The location and management quality of the business are not recorded.

When you evaluate, use these to qualify your conclusion, not as a stand-alone list.

Common errors

• Using total revenue instead of credit sales for receivable days, or total purchases when some were for cash.
• Using closing inventory when average inventory is required for turnover.
• Mixing up markup (on cost of sales) and margin (on revenue).
• Forgetting to add back interest in sole-trader ROCE.
• Writing a current ratio as a percentage instead of x:1.
• Saying a falling ratio is “bad” with no cause and no comparison.
• Treating a high current ratio as always good, when it may mean idle inventory or slow collection.
• Saying depreciation is a cash outflow.

Next, test recall with the revision notes and then try the practice questions. The exam preparation guide explains the structure of both papers.

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.