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Financial Statements Interpretation Flashcards

6 cards from real AAT L4 practice questions. Tap to flip, then mark Knew It or Still Learning — missed cards come back until you master them.

Read the first 6 Financial Statements Interpretation flashcards as text

  1. Company X has a current ratio of 1.8 and an acid test (quick) ratio of 0.7. What does this suggest about the company's liquidity?

    Answer: The company's liquidity depends heavily on converting inventory to cash, which may be a risk

    The large gap between current ratio (1.8) and acid test (0.7) indicates that most current assets are inventory. Since inventory is less liquid than cash or receivables, ability to meet short-term obligations depends on selling inventory quickly.

  2. A company's ROCE (return on capital employed) has fallen from 18% to 12% year-on-year. Operating profit has remained constant at £600,000. What has caused the ROCE to fall?

    Answer: Capital employed has increased significantly

    If ROCE = Operating profit ÷ Capital employed, and operating profit is constant, a fall in ROCE must be caused by an increase in capital employed. Previous CE = £600,000/18% = £3.33m. New CE = £600,000/12% = £5m — an increase of £1.67m.

  3. When interpreting a company's gearing ratio, which of the following indicates HIGH financial risk?

    Answer: Gearing of 75% and interest cover of 1.5 times

    High gearing (75% — most of the capital structure is debt) combined with low interest cover (1.5 times — profits barely cover interest) indicates high financial risk and vulnerability to economic downturns.

  4. A company has operating profit of £240,000, interest payable of £40,000, and tax of £56,000. What is the profit for the year (net profit after tax)?

    Answer: £144,000

    Profit before tax = £240,000 − £40,000 = £200,000. Profit after tax = £200,000 − £56,000 = £144,000.

  5. An analyst notices that a company's inventory days have increased from 35 days to 62 days over the year. Which of the following is the MOST likely concern this raises?

    Answer: The company may have slow-moving or obsolete inventory, or has over-purchased

    A near-doubling of inventory days suggests inventory is accumulating faster than it is being used or sold. This may indicate slow-moving or obsolete stock, over-purchasing, or slowing demand — all of which are concerning for liquidity and asset quality.

  6. Which financial statement ratio best indicates whether a company generates sufficient cash flow to service its debt obligations?

    Answer: Interest cover ratio

    The interest cover ratio (Operating profit ÷ Interest payable) directly measures how many times operating profit covers the interest charge, indicating ability to service debt from earnings.