AAT Level 4 - Professional Diploma in Accounting Financial Statements Interpretation 1

Question 1

A company reports operating profit of £270,000 and interest payable of £45,000. What is the interest cover ratio, and what does it indicate?

Accepted Answer

6 times — the company earns its interest charge 6 times over from operating profit, indicating a comfortable safety margin

Answer

Interest cover = Operating profit ÷ Interest payable = £270,000 ÷ £45,000 = 6 times. A higher interest cover ratio means the company can comfortably service its debt from operating profit; a ratio of 6 is generally considered healthy and low risk.

Question 2

A company's gross profit margin has remained steady at 40% over two consecutive years, but its net profit margin has declined from 18% to 10%. What is the most likely cause?

Accepted Answer

Distribution, administration, or other operating expenses have increased

Answer

Because the gross profit margin is unchanged, the relationship between revenue and cost of sales is stable — so the problem lies below the gross profit line. A falling net profit margin with a stable gross margin points to increased operating overheads such as distribution or administrative expenses.

Question 3

A business has trade receivables of £100,000 and annual credit revenue of £600,000. What is the receivables collection period (to the nearest day)?

Accepted Answer

61 days

Answer

Receivables collection period = (Trade receivables ÷ Credit revenue) × 365 = (£100,000 ÷ £600,000) × 365 = 60.8, rounded to 61 days. This represents the average number of days the business waits to collect payment from credit customers.

Question 4

A company generates revenue of £1,800,000 and has capital employed (net assets) of £1,200,000. What is the asset turnover ratio and what does it represent?

Accepted Answer

1.5 times — the business generates £1.50 of revenue for every £1 of capital employed

Answer

Asset turnover = Revenue ÷ Capital employed = £1,800,000 ÷ £1,200,000 = 1.5 times. It measures how efficiently a business uses its net assets to generate sales; a higher ratio suggests more efficient use of capital. This ratio is a component of the ROCE calculation (ROCE = Net profit margin × Asset turnover).

Question 5

A company has non-current liabilities of £300,000 and total equity of £700,000. Using the AAT gearing formula, what is the gearing ratio?

Accepted Answer

30% — gearing equals non-current liabilities divided by total capital employed

Answer

The AAT gearing formula is: Non-current liabilities ÷ (Non-current liabilities + Equity) × 100 = £300,000 ÷ £1,000,000 × 100 = 30%. This represents the proportion of long-term funding provided by debt rather than equity; 30% is generally considered low-to-moderate gearing.

AAT Level 4 Practice Test

AAT Level 4 Practice Test

AAT Level 4 - Professional Diploma in Accounting Financial Statements Interpretation 1