3.5 Analysis and Communication of Accounting Information

2026 Syllabus Objectives

By the end of this topic, you should be able to:

  1. Calculate the following ratios: working capital cycle (in days), net working assets to revenue, interest cover, gearing ratio, earnings per share (EPS), price/earnings (P/E) ratio, dividend per share, dividend yield, and dividend cover — using only the formulae given in the Cambridge 9706 appendix.
  2. Analyse and evaluate what the ratios tell us, and draw meaningful conclusions.
  3. Make appropriate recommendations to stakeholders based on ratio analysis.
  4. Understand the interrelationships between ratios — how one ratio connects to and affects another.
  5. Use ratio analysis to make informed business decisions using relevant information.

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1. Why Do We Calculate Ratios?

A ratio is a way of comparing two numbers to show a relationship between them. On their own, numbers from financial statements — like profit of $500,000 or debt of $2,000,000 — don't tell us very much. Is that profit good or bad? Is that debt dangerous? Ratios give these numbers meaning by comparing them to other figures.

Ratios are used to:

  • Assess performance — is the business doing well?
  • Identify trends — is the business getting better or worse over time?
  • Compare businesses — how does one company measure up against a competitor?
  • Help stakeholders make decisions — investors, lenders, managers, and employees all have different interests

Important rule: In your Cambridge exam, you must only use the formulae given in the appendix to Section 3 of the syllabus. Using a different version of a formula — even if it gives the same answer — will not be accepted.

2. The Nine Ratios You Must Know

These ratios fall into two broad groups:

  • Liquidity and efficiency ratios — how well the business manages its short-term finances and working capital
  • Investor ratios — information useful to shareholders and potential investors

2.1 Working Capital Cycle (in Days)

What it measures: How many days it takes for a business to turn its cash into goods, sell those goods, collect payment — and get its cash back again. This is also called the cash operating cycle.

Formula:

Working Capital Cycle=Inventory Days+Receivable Days−Payable Days\text{Working Capital Cycle} = \text{Inventory Days} + \text{Receivable Days} - \text{Payable Days}

Where:

Inventory Days=InventoryCost of Sales×365\text{Inventory Days} = \frac{\text{Inventory}}{\text{Cost of Sales}} \times 365 Receivable Days=Trade ReceivablesRevenue×365\text{Receivable Days} = \frac{\text{Trade Receivables}}{\text{Revenue}} \times 365 Payable Days=Trade PayablesCost of Sales×365\text{Payable Days} = \frac{\text{Trade Payables}}{\text{Cost of Sales}} \times 365

Plain English: Inventory days tells you how long stock sits in the warehouse. Receivable days tells you how long customers take to pay. Payable days tells you how long the business takes to pay its suppliers.

Example:

  • Inventory = $40,000 | Cost of Sales = $200,000 | Revenue = $300,000 | Receivables = $45,000 | Payables = $30,000
Inventory Days=40,000200,000×365=73 days\text{Inventory Days} = \frac{40{,}000}{200{,}000} \times 365 = 73 \text{ days} Receivable Days=45,000300,000×365=54.75 days\text{Receivable Days} = \frac{45{,}000}{300{,}000} \times 365 = 54.75 \text{ days} Payable Days=30,000200,000×365=54.75 days\text{Payable Days} = \frac{30{,}000}{200{,}000} \times 365 = 54.75 \text{ days} Working Capital Cycle=73+54.75−54.75=73 days\text{Working Capital Cycle} = 73 + 54.75 - 54.75 = 73 \text{ days}

Interpretation:

  • A shorter cycle is generally better — it means cash comes back to the business faster
  • A longer cycle means the business has cash tied up for longer, which can cause cash flow problems
  • Delaying paying suppliers (longer payable days) reduces the cycle — which is why businesses try to negotiate longer payment terms

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