S5 BAFS Practice Paper: Financial Statements And Ratio Analysis (12 Questions, 100 Marks, 75 Minutes)

S5 BAFS Practice Paper: Financial Statements and Ratio Analysis (12 questions, 100 marks, 75 minutes)

2026-11-09

S5 BAFS: Financial Statements and Ratio Analysis

S5 BAFS practice paper on financial statements and key ratios: margins, liquidity, efficiency and gearing, with year-on-year analysis. 12 questions, 100 marks, 75 minutes, answers.

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Section A: Statement Preparation and Basic Calculations (28 marks)

Answer all four questions in Section A and show all formulae and workings.

Question

Answer and marking notes

1. The following information relates to Wai Shun Trading Limited for the year ended 31 December 2025:

Item	Amount ($)
Sales revenue	2,400,000
Cost of goods sold	1,560,000
Operating expenses	540,000
Finance costs (interest)	36,000
Profits tax	46,000

(a) Prepare an income statement showing gross profit, operating profit, profit before tax and profit for the year; (b) calculate the gross profit margin and the net profit margin (one decimal place). (7 marks)

(a) Income statement: sales revenue $2,400,000; less cost of goods sold $1,560,000 giving gross profit $840,000; less operating expenses $540,000 giving operating profit $300,000; less finance costs $36,000 giving profit before tax $264,000; less profits tax $46,000 giving profit for the year $218,000. (4 marks: layout 1, gross profit 1, operating profit 1, profit after tax 1) (b) Gross profit margin = 840,000 / 2,400,000 x 100% = 35.0%; net profit margin = 218,000 / 2,400,000 x 100% = 9.1%. (3 marks: formula 1 each, answer 1 each, percentages shown) Marking note: interest is a financing cost and must not be included in operating expenses; the net margin uses profit after tax, not profit before tax. Common error: adding cost of goods sold to operating expenses loses the gross profit mark.

2. Current items at 31 December 2025: inventory $320,000, trade receivables $400,000 and cash $80,000; total current liabilities $400,000. (a) Calculate the current ratio; (b) calculate the quick ratio; (c) calculate the inventory turnover (times, two decimal places) and the inventory holding period (one decimal place). (7 marks)

(a) Current ratio = current assets / current liabilities = 800,000 / 400,000 = 2.0:1. (b) Quick ratio = (current assets – inventory) / current liabilities = (800,000 – 320,000) / 400,000 = 1.2:1. (c) Inventory turnover = cost of goods sold / inventory = 1,560,000 / 320,000 = 4.88 times; inventory holding period = 365 / 4.88 = 74.8 days. Marking note: the quick ratio must exclude inventory because inventory may not be realised quickly; the turnover uses cost of goods sold, not sales revenue, and the wrong numerator earns the formula mark only.

3. Using the data above, sales revenue is $2,400,000, cost of goods sold $1,560,000 and trade payables $260,000. (a) Calculate the receivables collection period (one decimal place); (b) calculate the payables payment period (one decimal place); (c) using the inventory holding period from 2(c), calculate the cash conversion cycle and explain its meaning. (7 marks)

(a) Receivables collection period = receivables / sales revenue x 365 = 400,000 / 2,400,000 x 365 = 60.8 days. (b) Payables payment period = payables / cost of goods sold x 365 = 260,000 / 1,560,000 x 365 = 60.8 days. (c) Cash conversion cycle = 60.8 + 74.8 – 60.8 = 74.8 days. Meaning: on average the company waits 74.8 days between paying for goods and collecting cash from customers, and must fund that gap from its own resources or an overdraft; the longer the cycle, the greater the funding pressure. (3 marks: working 1, answer 1, explanation 1) Marking note: the payables period uses cost of goods sold, consistent with inventory turnover; using sales revenue is a conceptual error.

4. At 31 December 2025: total assets $2,000,000, current liabilities $400,000, 10% debentures $400,000, equity $1,200,000; operating profit for the year $300,000, finance costs $36,000 and profit for the year $218,000. (a) Calculate the return on capital employed; (b) calculate the gearing ratio (debentures divided by debentures plus equity); (c) calculate the interest cover (one decimal place). (7 marks)

(a) Return on capital employed = operating profit / (total assets – current liabilities) x 100% = 300,000 / (2,000,000 – 400,000) x 100% = 300,000 / 1,600,000 x 100% = 18.8%. (b) Gearing ratio = 400,000 / (400,000 + 1,200,000) x 100% = 25.0%. (c) Interest cover = operating profit / finance costs = 300,000 / 36,000 = 8.3 times. Marking note: (a) uses operating profit, before interest and tax, over capital employed rather than total assets; (c) the higher the cover the safer the interest payments, and 8.3 times is a sound level.

Section B: Ratio Analysis and Year-on-Year Comparison (32 marks)

Use the data given in Section B and round answers to one decimal place.

Question

Answer and marking notes

5. The following compares 2024 and 2025:

Item	2024	2025
Sales revenue ($)	2,000,000	2,400,000
Gross profit margin	36.0%	35.0%
Net profit margin	10.0%	9.1%
Current ratio	2.4	2.0
Inventory turnover (times)	5.2	4.88
Receivables period (days)	48.0	60.8

Profit for the year in 2024 was $200,000. (a) Calculate the growth rates of sales revenue and of profit for the year (one decimal place); (b) identify three ratios that deteriorated in 2025 and give one possible reason for each; (c) explain why revenue growth does not necessarily mean improved profitability. (8 marks)

(a) Sales growth = (2,400,000 – 2,000,000) / 2,000,000 x 100% = 20.0%; profit growth = (218,000 – 200,000) / 200,000 x 100% = 9.0%. (b) Three deteriorated ratios with possible reasons: (i) gross margin fell from 36.0% to 35.0% because of price cuts to clear stock or because purchase costs rose without being passed on; (ii) the current ratio fell from 2.4 to 2.0 as short-term borrowings or payables grew faster than current assets; (iii) the receivables period rose from 48.0 to 60.8 days because credit terms were relaxed to win sales or because customers are paying more slowly. (c) Revenue grew 20.0% while profit grew only 9.0% and the net margin fell from 10.0% to 9.1%, so growth was bought with discounts and easier credit and each dollar of sales now earns less profit; profitability has therefore not improved. Marking note: the two growth rates must be contrasted; stating only that revenue rose scores nothing.

6. Inventory turnover fell from 5.2 times in 2024 to 4.88 times in 2025. (a) Calculate the inventory holding period for both years and the increase in days (one decimal place); (b) give two possible reasons for the fall; (c) explain two effects of holding excess inventory on cash flow and on operating costs. (8 marks)

(a) 2024 holding period = 365 / 5.2 = 70.2 days; 2025 = 365 / 4.88 = 74.8 days; the increase is 74.8 – 70.2 = 4.6 days. (b) Possible reasons: (i) bulk buying to meet supplier minimum order quantities or to beat expected price rises; (ii) part of the stock is slow-moving or out of date and has not been sold. (c) Effects: (i) cash is locked in inventory and must be funded by overdraft or loans, raising interest cost; (ii) warehouse rent, insurance, obsolescence and shrinkage costs rise, and a write-down of slow-moving stock may be needed. Marking note: (b) must give one buying reason and one selling reason; two of the same kind earn one mark only.

7. The receivables collection period rose from 48.0 days in 2024 to 60.8 days in 2025, when sales revenue was $2,400,000. (a) Calculate the additional funds tied up by the longer collection period (to the nearest dollar); (b) if those funds must be borrowed at 6% per annum, calculate the extra annual interest cost; (c) suggest two measures to shorten the collection period and state one cost of each. (8 marks)

(a) Additional funds tied up = (60.8 – 48.0) / 365 x 2,400,000 = 12.8 / 365 x 2,400,000 = about $84,164. (b) Extra annual interest = $84,164 x 6% = about $5,050. (c) Measures and costs: (i) offer a cash discount such as 2/10, n/30, which reduces revenue and squeezes the gross margin; (ii) tighten credit checks and collection and suspend supplies to overdue customers, which raises administrative cost and may lose some customers. Marking note: (a) must use the change in days rather than the year-end receivables balance; a measure without its cost earns nothing.

8. Operating profit was $300,000 and finance costs $36,000 in 2025, the whole of the finance cost being interest on $400,000 of 10% debentures. (a) Calculate the interest cover for 2025 (one decimal place); (b) if the company issues a further $200,000 of 8% debentures while operating profit is unchanged, calculate the new interest cover (one decimal place); (c) comment on whether the company should raise more debt, using both results. (8 marks)

(a) Interest cover = 300,000 / 36,000 = 8.3 times. (b) New interest = 36,000 + 16,000 = 52,000; new cover = 300,000 / 52,000 = 5.8 times. (c) Cover falls from 8.3 to 5.8 times, still above the usual safety range of 3 to 4 times, so short-term interest payments remain manageable; however, operating profit needs to fall only about 48% for cover to approach 3 times, and gearing would rise to 33.3%. Further borrowing is justified only if the expansion reliably adds operating profit; otherwise the company should first improve its inventory and receivables turnover. (Both sides required) Marking note: a bare yes or no without figures scores at most two marks.

Section C: Discussion and Decision Questions (40 marks)

Section C requires a clear stand, supporting calculations and concrete recommendations.

Question

Answer and marking notes

9. “Ratio analysis gives a complete picture of a company financial health.” Discuss this statement, giving at least four limitations of ratio analysis and illustrating them with the data of this company. (10 marks)

Stand: ratio analysis is useful but incomplete. Four limitations with this company data: (i) Historical cost – assets are carried at purchase price, so in inflation the replacement cost is understated and the return on capital employed of 18.8% is overstated; (ii) Comparability – acceptable ratios differ by industry, and inventory turnover of 4.88 times would be low for a fast-moving consumer goods business but normal for heavy machinery; (iii) Window dressing – buying can be delayed and receivables collected just before the year end, so the current ratio of 2.0 is flattered on the reporting date and falls back afterwards; (iv) Only quantitative data – management quality, customer concentration, brand strength and litigation never appear in the accounts; (v) Profit is not cash – profit for the year was $218,000 while the receivables period rose to 60.8 days, so part of that profit is still uncollected. Conclusion: ratios must be read together with the cash flow statement, industry benchmarks and multi-year trends, and with the qualitative disclosures in the notes. Marking note: each limitation needs an explanation and an example (2 marks each), conclusion 2 marks; names alone score nothing.

10. Wai Shun Trading Limited needs $200,000 to expand. Option 1: issue 8% debentures with annual interest of $16,000. Option 2: issue 100,000 new shares at $2 each. There are 600,000 shares in issue and profit for 2025 was $218,000; the expansion is expected to add $30,000 to operating profit each year. (a) Calculate earnings per share under each option (three decimal places); (b) calculate the gearing ratio under each option; (c) state which option is better for existing shareholders and explain the main risk of each. (10 marks)

(a) Option 1 (debentures): profit available = 218,000 + 30,000 – 16,000 = 232,000; EPS = 232,000 / 600,000 = $0.387. Option 2 (new shares): profit available = 218,000 + 30,000 = 248,000; shares = 600,000 + 100,000 = 700,000; EPS = 248,000 / 700,000 = $0.354. (Benchmark: with no expansion EPS = 218,000 / 600,000 = $0.363.) (b) Option 1 gearing = (400,000 + 200,000) / (400,000 + 200,000 + 1,200,000) x 100% = 33.3%; Option 2 gearing = 400,000 / (400,000 + 1,200,000 + 200,000) x 100% = 22.2%. (c) Option 1 gives the higher EPS ($0.387 against $0.354) and so is better for existing shareholders, because interest is tax deductible and no shares are diluted; but it lifts gearing to 33.3% and the interest becomes a fixed burden if profit falls. Option 2 keeps gearing down at 22.2% and is less risky but dilutes EPS and shares future profits with new holders. Recommendation: choose option 1 if the expansion generates stable cash flow and interest cover can stay above 4 times; otherwise choose option 2. Marking note: 1.5 marks for each EPS working; (c) must mention both dilution and financial risk.

11. “Our current ratio of 2.0 shows that liquidity is sound.” Comment on this statement, using the share of inventory in current assets, the quick ratio and the movement in the receivables period as evidence. (10 marks)

Stand: a current ratio of 2.0:1 alone does not prove sound liquidity. Three figures show the risk: (i) inventory of $320,000 is 320,000 / 800,000 = 40.0% of current assets while the quick ratio is only 1.2:1, so nearly half of current assets are stock that may not convert to cash quickly; (ii) inventory turnover has fallen to 4.88 times (74.8 days held), so stock is ageing and becoming less realisable; (iii) the receivables period has risen from 48.0 to 60.8 days, so collection has slowed and receivables quality has weakened; the current ratio itself has also fallen from 2.4 to 2.0, a downward trend. Conclusion: 2.0:1 only shows that book values of current assets cover current liabilities; it ignores asset quality and cash generation, and if stock must be discounted or receivables prove bad, real liquidity will be well below the ratio suggests. Marking note: the three data points are worth 2 marks each, a clear stand 2 marks and the conclusion 2 marks.

12. Industry averages and the company ratios are as follows:

Ratio	Industry	Company
Gross profit margin	38.0%	35.0%
Net profit margin	8.0%	9.1%
Inventory turnover (times)	6.00	4.88
Receivables period (days)	45.0	60.8
Gearing ratio	30.0%	25.0%

(a) Compare the company with the industry on profitability, operating efficiency and financial risk; (b) give two specific recommendations and state which ratio each would improve. (10 marks)

(a) Profitability: gross margin of 35.0% is below the industry 38.0% but net margin of 9.1% is above the industry 8.0%, showing that gross profit is eroded by discounting while operating costs are controlled well. Efficiency: inventory turnover of 4.88 times is below the industry 6.00 times and the receivables period of 60.8 days is far above the industry 45.0 days, so working capital turns over slowly and efficiency lags. Financial risk: gearing of 25.0% is below the industry 30.0%, so leverage is conservative and risk low, though possibly too conservative in not using cheaper debt. (b) Recommendations: (i) clear slow-moving stock and order in smaller, more frequent batches to lift inventory turnover from 4.88 towards 5.5 times or more, releasing cash and cutting storage cost; (ii) tighten credit policy (cash before delivery for new customers, stop supply when overdue) to move the receivables period from 60.8 days towards 45 days and reduce reliance on the overdraft. Marking note: each area needs comparison and explanation (2 marks each) and each recommendation must be linked to a named ratio (2 marks each).

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