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Analysis and communication of accounting information (A Level)

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Cambridge International AS & A Level Accounting 9706

Analysis and Communication of Accounting Information (A Level)

The big idea: At A Level the analysis moves from “is the business doing well?” to “is it safe to lend to, and worth investing in?”. Solvency ratios measure how working capital is managed and how much the company depends on borrowing, and investment ratios relate the profit and dividends to each share and to its market price.

Summary — What This Chapter Covers

Working capital cycle (days) = trade receivables days + inventory days − trade payables days.
Net working assets to revenue (%) = (inventories + trade receivables − trade payables) / revenue × 100.
Interest cover = profit from operations / interest payable. Gearing = non-current liabilities / (issued ordinary share capital + all reserves + non-current liabilities) × 100.
EPS = profit for the year / number of issued ordinary shares; P/E = market price / EPS.
DPS = annual ordinary dividend (interim paid + final proposed) / number of shares; dividend yield = DPS / market price; dividend cover = profit available for ordinary dividend / annual ordinary dividend.
Ratios are linked: more borrowing raises gearing and lowers interest cover; lower EPS at the same price raises the P/E ratio.
Recommendations must name the stakeholder, use the ratios that matter to them, and weigh both sides before a decision.

1. Working Capital Cycle and Net Working Assets

Syllabus 3.5.1 · A Level · Paper 3

How long cash is tied up in trading

Orion plc is used throughout this chapter. The figures below are extracts from its financial statements.

Orion plc: extracts for the years ended 31 December
	2024 $	2025 $
Revenue (all on credit)	2,000,000	2,400,000
Cost of sales	1,240,000	1,560,000
Credit purchases	1,250,000	1,600,000
Profit from operations	340,000	360,000
Finance costs (debenture interest)	40,000	80,000
Tax	60,000	56,000
Profit for the year	240,000	224,000
Inventory at start of year	210,000	220,000
Inventory at end of year	220,000	260,000
Trade receivables at end of year	250,000	330,000
Trade payables at end of year	150,000	200,000
Ordinary shares of $1 each	1,600,000	1,600,000
All reserves	1,300,000	1,400,000
8% debentures (non-current liabilities)	500,000	1,000,000
Interim ordinary dividend paid	48,000	48,000
Final ordinary dividend proposed	96,000	80,000
Market price per share at year end	2.10	1.68

The working capital cycle is the number of days between paying suppliers for goods and receiving cash from customers for them. Goods sit in inventory, are sold on credit, and the customer pays later; the business’s own credit from suppliers shortens the wait. The shorter the cycle, the less finance the business needs for its working capital.

Ratio	Formula	2024	2025
Trade receivables turnover	Trade receivables / credit sales × 365	250,000 / 2,000,000 × 365 = 45.63 days	330,000 / 2,400,000 × 365 = 50.19 days
Inventory turnover	Average inventory / cost of sales × 365	215,000 / 1,240,000 × 365 = 63.29 days	240,000 / 1,560,000 × 365 = 56.15 days
Trade payables turnover	Trade payables / credit purchases × 365	150,000 / 1,250,000 × 365 = 43.80 days	200,000 / 1,600,000 × 365 = 45.63 days
Working capital cycle	Receivables days + inventory days − payables days	45.63 + 63.29 − 43.80 = 65.12 days	50.19 + 56.15 − 45.63 = 60.71 days
Net working assets to revenue	(Inventories + trade receivables − trade payables) / revenue × 100

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How much depends on borrowed money?
Earnings, dividends and the share price
Ratios explain each other
Using the ratios to advise

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Analysis and communication of accounting information (A Level)

Analysis and Communication of Accounting Information (A Level)

How long cash is tied up in trading

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