Subject: Accounting · Type: Assignment · Level: Undergraduate · ~1879 words · Harvard referencing
Written by an AHC subject expert in Accounting, to a first-class / distinction standard. This is an original sample provided for reference and learning — please do not submit it as your own work.
Sample assignment produced by Assignment Help Center to illustrate the standard of academic writing we provide. The company, Meridian Trading Ltd, and all financial figures are entirely illustrative and were created for teaching purposes; they do not represent any real business. All calculations have been independently checked. Nothing in this assignment constitutes investment advice.
1. Introduction
The purpose of this assignment is to demonstrate how a set of summarised financial statements can be prepared in outline and then interrogated using ratio analysis. Financial statements are, in the first instance, simply a structured record of transactions, but their real value lies in what they reveal once the raw figures are converted into relationships. Ratio analysis performs exactly this conversion, expressing one figure as a proportion of another so that the performance and position of a business can be judged against its own past, against competitors, and against the expectations of investors and lenders (Atrill and McLaney, 2019). This assignment sets out an illustrative income statement and statement of financial position for a fictitious wholesaler, Meridian Trading Ltd, for the year ended 31 December 2024 with comparatives for 2023. It then calculates and interprets a range of profitability, liquidity, efficiency and gearing ratios, before evaluating the well-documented limitations of the technique. The intention throughout is to show not only how ratios are computed but, more importantly, how they should be read.
2. Summarised financial statements
The statements have been prepared on the conventional bases that underpin published accounts: the accruals concept, under which income and expenses are recognised as they are earned or incurred rather than when cash changes hands, and the going-concern assumption, under which the business is presumed to continue in operation for the foreseeable future (Weetman, 2019). The figures below are presented in the vertical format required by the Companies Act 2006 and IAS 1, with the income statement classifying expenses by function and the statement of financial position ordering items so that the accounting equation, assets equal liabilities plus equity, is transparent (Elliott and Elliott, 2019). All amounts are in pounds sterling.
Table 1 — Meridian Trading Ltd: Summarised income statement for the year ended 31 December 2024
| 2024 (£) | 2023 (£) | |
|---|---|---|
| Revenue | 2,400,000 | 2,000,000 |
| Cost of sales | (1,560,000) | (1,300,000) |
| Gross profit | 840,000 | 700,000 |
| Operating expenses | (540,000) | (460,000) |
| Operating profit | 300,000 | 240,000 |
| Finance costs | (60,000) | (56,000) |
| Profit before tax | 240,000 | 184,000 |
| Taxation | (48,000) | (37,000) |
| Profit for the year | 192,000 | 147,000 |
Table 2 — Meridian Trading Ltd: Summarised statement of financial position as at 31 December 2024
| 2024 (£) | 2023 (£) | |
|---|---|---|
| Non-current assets | 1,400,000 | 1,300,000 |
| Inventory | 320,000 | 280,000 |
| Trade receivables | 300,000 | 250,000 |
| Cash and cash equivalents | 80,000 | 70,000 |
| Current assets | 700,000 | 600,000 |
| Total assets | 2,100,000 | 1,900,000 |
| Trade payables | 260,000 | 230,000 |
| Other payables (tax and accruals) | 140,000 | 120,000 |
| Current liabilities | 400,000 | 350,000 |
| Long-term bank loan | 600,000 | 560,000 |
| Non-current liabilities | 600,000 | 560,000 |
| Share capital | 500,000 | 500,000 |
| Retained earnings | 600,000 | 490,000 |
| Total equity | 1,100,000 | 990,000 |
| Total equity and liabilities | 2,100,000 | 1,900,000 |
Two internal consistency checks confirm that the statements articulate correctly. First, total equity and liabilities equal total assets in both years (£2,100,000 in 2024 and £1,900,000 in 2023), so the accounting equation holds. Second, the movement in retained earnings is coherent: opening reserves of £490,000 plus profit for the year of £192,000 give £682,000, from which an implied dividend of £82,000 leaves the closing balance of £600,000. Capital employed, defined here as total equity plus non-current liabilities, is therefore £1,700,000 in 2024 (£1,100,000 + £600,000) and £1,550,000 in 2023, a figure that is used repeatedly in the analysis below.
3. Ratio calculations and working
Each ratio is defined, worked and briefly interpreted in this section; the wider discussion follows in Section 4. The results are collected in Table 3.
3.1 Profitability
Profitability ratios measure how effectively the business converts sales and invested capital into profit (Weetman, 2019).
- Gross profit margin = gross profit ÷ revenue = 840,000 ÷ 2,400,000 = 35.0% (2023: 700,000 ÷ 2,000,000 = 35.0%).
- Operating profit margin = operating profit ÷ revenue = 300,000 ÷ 2,400,000 = 12.5% (2023: 12.0%).
- Return on capital employed (ROCE) = operating profit ÷ capital employed = 300,000 ÷ 1,700,000 = 17.6% (2023: 240,000 ÷ 1,550,000 = 15.5%).
- Return on equity (ROE) = profit for the year ÷ total equity = 192,000 ÷ 1,100,000 = 17.5% (2023: 14.8%).
The stable gross margin shows that Meridian has maintained its pricing and purchasing discipline even as revenue grew by 20%. Because operating profit has risen faster than revenue, the operating margin has improved, indicating that overheads have not grown in proportion to sales and that the business is enjoying a degree of operating leverage. ROCE, widely regarded as the primary measure of managerial performance because it relates profit to the resources used to generate it, has strengthened from 15.5% to 17.6% (Atrill and McLaney, 2019).
3.2 Liquidity
Liquidity ratios test whether short-term assets are sufficient to meet short-term obligations as they fall due (Atrill and McLaney, 2019).
- Current ratio = current assets ÷ current liabilities = 700,000 ÷ 400,000 = 1.75:1 (2023: 600,000 ÷ 350,000 = 1.71:1).
- Quick (acid-test) ratio = (current assets − inventory) ÷ current liabilities = (700,000 − 320,000) ÷ 400,000 = 0.95:1 (2023: 0.91:1).
Both measures are broadly stable and have edged upwards. A current ratio of 1.75 indicates that current assets comfortably cover current liabilities, while a quick ratio slightly below 1.0 shows that, if inventory could not be sold, the company would rely on collecting receivables to settle its immediate debts. For a wholesaler holding readily saleable stock, this position is unremarkable rather than alarming, though it leaves little margin for error and warrants monitoring.
3.3 Efficiency
Efficiency, or activity, ratios reveal how well the business manages its working capital and assets (Elliott and Elliott, 2019).
- Inventory turnover period = (inventory ÷ cost of sales) × 365 = (320,000 ÷ 1,560,000) × 365 = 74.9 days, equivalent to 4.88 times a year (2023: 78.6 days).
- Trade receivables collection period = (trade receivables ÷ revenue) × 365 = (300,000 ÷ 2,400,000) × 365 = 45.6 days (2023: 45.6 days).
- Trade payables payment period = (trade payables ÷ credit purchases) × 365. Purchases are derived as cost of sales plus closing inventory less opening inventory = 1,560,000 + 320,000 − 280,000 = 1,600,000, giving (260,000 ÷ 1,600,000) × 365 = 59.3 days.
- Total asset turnover = revenue ÷ total assets = 2,400,000 ÷ 2,100,000 = 1.14 times (2023: 1.05 times).
Inventory is now being sold marginally faster than in the previous year, releasing cash, and the collection period is steady at just over six weeks. Meridian takes almost 60 days to pay suppliers while collecting from customers in under 46 days, so the payables period comfortably exceeds the receivables period; the business is, in effect, being partly financed by its suppliers, which eases pressure on cash. Total asset turnover has improved, confirming that the enlarged asset base is generating proportionately more sales.
3.4 Gearing
Gearing ratios measure the extent to which the business is financed by debt rather than by shareholders’ funds, and therefore capture financial risk (McLaney and Atrill, 2018).
- Gearing (debt-to-equity) = long-term debt ÷ total equity = 600,000 ÷ 1,100,000 = 54.5% (2023: 56.6%).
- Interest cover = operating profit ÷ finance costs = 300,000 ÷ 60,000 = 5.0 times (2023: 4.29 times).
Gearing has fallen slightly because equity has grown through retained profit while debt has risen only modestly, so the proportion of the business funded by borrowing has declined. Interest cover has improved to five times, meaning operating profit could fall substantially before the company struggled to meet its interest obligations. Taken together, these figures suggest a moderate and improving risk profile.
Table 3 — Summary of ratios
| Ratio | 2024 | 2023 | Trend |
|---|---|---|---|
| Gross profit margin | 35.0% | 35.0% | Stable |
| Operating profit margin | 12.5% | 12.0% | Improving |
| ROCE | 17.6% | 15.5% | Improving |
| Return on equity | 17.5% | 14.8% | Improving |
| Current ratio | 1.75 | 1.71 | Stable |
| Quick ratio | 0.95 | 0.91 | Stable |
| Inventory turnover | 74.9 days | 78.6 days | Improving |
| Receivables collection | 45.6 days | 45.6 days | Stable |
| Payables payment | 59.3 days | — | — |
| Total asset turnover | 1.14x | 1.05x | Improving |
| Gearing (D/E) | 54.5% | 56.6% | Improving |
| Interest cover | 5.0x | 4.29x | Improving |
4. Interpretation
Read as a set rather than individually, the ratios tell a consistent and encouraging story about Meridian Trading Ltd. Revenue has grown by a fifth, and profitability has grown faster still, so that returns on both capital employed and equity have improved. The usefulness of this reading depends entirely on comparison, because a single ratio in isolation conveys very little: an ROCE of 17.6% means nothing until it is set against the prior year, a competitor, or an industry benchmark (Atrill and McLaney, 2019). Here the comparison is with the company’s own prior year, and the direction of travel is positive across almost every measure.
The interrelationships between ratios are particularly instructive and can be made explicit through the DuPont decomposition, which expresses ROCE as the product of the operating margin and net asset turnover (Wild, Subramanyam and Halsey, 2007). Meridian’s operating margin of 12.5% multiplied by its net asset turnover of 1.41 times (revenue of 2,400,000 divided by capital employed of 1,700,000) reproduces the ROCE of 17.6% exactly. This confirms that the improvement in ROCE has been driven both by better margins and by more intensive use of the capital base, rather than by one factor alone. Such a diagnostic breakdown is more informative than the headline figure, because it directs attention to the specific levers management has pulled.
It is also worth reading the same figures through the eyes of the different users of the accounts, because a single set of ratios serves several audiences with distinct concerns. A prospective lender would concentrate on the gearing of 54.5% and the interest cover of five times, concluding that the loan is well protected and that the company retains the capacity to borrow further if it needs to. An equity investor would attend more closely to the return on equity of 17.5% and to the trajectory of the operating margin, since these speak to the reward available on their stake. Management, for its part, would use the DuPont breakdown to decide where further gains might be found, and would monitor the working-capital ratios week by week rather than once a year. The same statements, in other words, support a range of decisions, and the analyst’s task is to select and weight the ratios that bear on the question actually being asked rather than to compute every ratio mechanically.
The liquidity and working-capital position reinforces this picture without contradicting it. The company holds enough current assets to meet its obligations, its stock is turning over slightly more quickly than before, and the gap between its long payables period and shorter receivables period means that day-to-day operations are partly funded by supplier credit. That said, a quick ratio below 1.0 is a reminder that the comfortable current ratio depends on inventory being saleable, and the analysis would be incomplete without reference to the statement of cash flows, which is harder to manipulate than accrual-based profit and provides a reality check on earnings quality and liquidity (Weetman, 2019). On the evidence available, Meridian appears to be a soundly financed, moderately geared business whose performance improved during the year.
5. Limitations of ratio analysis
However favourable these results appear, they must be treated with caution, because ratio analysis suffers from well-recognised limitations. Most fundamentally, ratios inherit every weakness of the financial statements from which they are drawn. Under the historical cost convention, non-current assets are typically recorded at their original purchase price rather than their current value, so a business with older assets may report a lower capital-employed figure and hence a flattering ROCE that reflects accounting convention rather than superior performance (Elliott and Elliott, 2019). Inflation compounds this by eroding the comparability of figures measured at different dates, so that nominal revenue growth may overstate real progress (Weetman, 2019).
A second difficulty is comparability across companies. Accounting standards permit legitimate choices in areas such as depreciation method and inventory valuation, so two otherwise identical firms can report different ratios purely because of differing policies. This is precisely why the IASB Conceptual Framework identifies comparability as an enhancing qualitative characteristic of useful information, while acknowledging that it is not always achieved in practice (IASB, 2018). Comparison is harder still across industries and national borders, and an industry average can be distorted by a few atypical firms. There is also the danger of window dressing, whereby transactions are arranged around the year-end to improve the reported position, to which snapshot measures such as the current ratio are especially vulnerable (McLaney and Atrill, 2018).
Finally, and most importantly for a business making forward-looking decisions, ratios are backward-looking and narrowly financial. They describe where a company has been, not where it is going, and they capture nothing of the intangible factors that increasingly drive value: brand strength, the quality of management, customer loyalty and exposure to regulatory or environmental risk (Elliott and Elliott, 2019). Meridian’s improving ratios are reassuring, but they cannot by themselves guarantee that the trend will continue if its competitive environment changes.
6. Conclusion
This assignment has prepared an illustrative set of financial statements and used them to compute and interpret a full range of ratios. The analysis shows that ratio analysis is a genuinely powerful tool for organising financial information, revealing relationships and framing questions: Meridian Trading Ltd emerges as a profitable, liquid and moderately geared business whose performance strengthened between 2023 and 2024. Yet the same analysis demonstrates why ratios must be handled critically. They rest on accounting numbers shaped by convention and judgement, they can be undermined by inconsistent policies and window dressing, and they are silent on the future and on the qualitative factors that often matter most. The appropriate conclusion is not to distrust ratios but to use them with discipline: interpreted as a set, tracked over time, read alongside the cash-flow statement and the narrative disclosures, and married to qualitative judgement, ratios are best understood as the beginning of an investigation rather than its conclusion (Atrill and McLaney, 2019).
Reference list
Atrill, P. and McLaney, E. (2019) Accounting and Finance for Non-Specialists. 11th edn. Harlow: Pearson.
Elliott, B. and Elliott, J. (2019) Financial Accounting and Reporting. 19th edn. Harlow: Pearson.
IASB (2018) Conceptual Framework for Financial Reporting. London: IFRS Foundation.
McLaney, E. and Atrill, P. (2018) Accounting and Finance: An Introduction. 9th edn. Harlow: Pearson.
Weetman, P. (2019) Financial and Management Accounting: An Introduction. 8th edn. Harlow: Pearson.
Wild, J.J., Subramanyam, K.R. and Halsey, R.F. (2007) Financial Statement Analysis. 9th edn. New York: McGraw-Hill.
Need a custom assignment like this?
Get an original, expertly written Accounting assignment tailored to your brief — fully referenced and plagiarism-checked.
Get expert help →