Connect ratio analysis with business strategy
Compare performance over time and against competitors, trace strategic choices through ratios, and evaluate limitations of published accounts.
Cambridge International AS & A Level Business 9609, 2026–2028 syllabus and 2029 syllabus, section 10.4.2. Ratio calculations use the formulae listed in the relevant Cambridge syllabus. Written practice is self-checked. Specialist review has not been completed for this lesson; these exercises do not award an official mark or establish exam readiness.
Before you begin
- Read the figures, dates and assumptions supplied in the question before calculating or interpreting an accounting result.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
What is a sound first step when a ratio changes sharply?
What you will learn
- Assess performance trends and competitor comparisons
- Trace debt/equity, dividend, growth and other strategies through ratios
- Explain the limits of published accounts and ratio analysis
Compare ratios before drawing conclusions
Ratio analysis can track performance over time and compare a business with competitors. Use comparable periods, definitions, scale and accounting policies; investigate whether a movement comes from price, costs, asset investment, borrowing, working capital or market conditions.
A ratio is a relationship between selected figures, not a complete measure of business success. Pair it with absolute amounts, cash-flow data, operational measures, stakeholder effects and strategic objectives.
Strategy can move several ratios
Debt funding may increase gearing and fixed interest exposure; issuing equity may lower gearing but dilute ownership. A larger dividend may raise immediate shareholder income but reduce retained funds and dividend cover. Growth can raise revenue and profit, but new assets or inventory may initially lower ROCE or liquidity.
Other strategies such as price reductions, staff investment, marketing, automation or cost control can affect margins, sales, capacity, cash and working capital in different directions. Published accounts are historical; seasonal timing, inflation, one-off items, group structures, accounting choices and non-financial performance limit comparisons. Explain the causal chain and the evidence needed to test it.
Pause and explain
A business borrows to expand, increasing non-current liabilities and capital employed. What happens to gearing if debt grows faster than total capital?
Worked example
A business reports revenue growth of 20%, lower ROCE, lower liquidity and higher gearing after opening new sites with borrowed funds. Assess what the ratios suggest and what the board should check before changing strategy.
Show the worked solution
- Expansion may increase capital employed, debt and short-term cash needs before sites mature.
- Check site-level revenue, margins, utilisation, opening costs, cash forecasts and debt terms.
- Compare the strategy's long-term returns and risk with the original plan and alternatives.
Answer The lower ROCE may reflect a larger capital-employed base before new sites generate full profit; lower liquidity may reflect launch costs or working capital, while higher gearing indicates greater debt share and fixed commitments. The board should examine site-level demand and margins, utilisation, cash timing, debt terms and forecast sensitivity. If the sites are on plan and can mature safely, a temporary decline may be acceptable; persistent underperformance may require changes. Ratios alone do not establish either conclusion.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
A firm issues shares to repay debt and cuts its dividend to finance new equipment. Explain one likely ratio effect from each decision and one trade-off.
Give me a hint
Follow the numerator and denominator affected by each funding decision.
Compare my reasoning
- Equity replaces some debt, so gearing normally falls all else equal.
- A lower annual dividend can raise dividend cover if profit is unchanged.
- The trade-offs include dilution, lower current income and whether equipment earns a return.
Repaying debt with new equity normally lowers gearing by reducing non-current liabilities and increasing equity in capital employed, all else equal. Cutting dividends can raise dividend cover if profit is unchanged, but reduces current shareholder income. New shares may dilute ownership; the equipment must generate sufficient returns to justify the funding choice.
Look for these in your work
- Debt/equity effect is traced
- Dividend-cover direction is conditional
- Stakeholder and investment trade-offs are assessed
A company doubles revenue after acquiring a competitor, but profit rises only slightly and inventory days increase. Explain why growth should not be called a success from revenue alone.
Give me a hint
Check profit quality, acquisition costs, working capital and comparability.
Compare my reasoning
- Profit may rise less than revenue because costs or integration expenses increased.
- More inventory days may tie up cash or signal slower stock movement.
- Separate acquired and organic results and assess debt, margins, cash and service.
Revenue growth alone does not show improved returns. Higher integration costs may limit profit, while more inventory days can tie up cash or reflect a different product mix. The board should examine like-for-like margins, acquisition and financing costs, stock ageing, cash generation, service and whether the growth meets strategic goals.
Look for these in your work
- Revenue and profit are distinguished
- Efficiency/liquidity consequence is explained
- Comparison and strategy evidence are selected
Two competitors have different ROCE and gearing. Give three reasons the comparison may be misleading and explain how to strengthen it.
Give me a hint
Use like-for-like ratios and corroborating evidence.
Compare my reasoning
- Check accounting policies, asset ages and reporting dates.
- Compare product mix, capital intensity, sector, inflation and one-off items.
- Use multi-year trends, absolute figures, cash flows and operating evidence.
The comparison may be distorted by different asset age/valuation or accounting policies, unlike reporting periods, different capital intensity or one-off items. Strengthen it by matching periods and definitions, comparing multi-year trends and sector context, and checking absolute profit, capital, cash flows, utilisation and strategy before ranking performance.
Look for these in your work
- Three relevant limitations are identified
- Comparability method is improved
- Additional evidence supports a fair conclusion
Common mistakes
- Assuming a ratio movement has only one cause
- Comparing businesses without checking periods, definitions and policies
- Treating accounting data as a complete measure of strategy or stakeholder outcomes
What can you explain now?
What is a sound first step when a ratio changes sharply?
Compare with the explanation
Investigate the underlying figures and context
A ratio does not reveal its cause by itself.
After trying it yourself, choose your next review. This is your self-assessment.
Your review choice appears on Today. Sign in to sync it across devices.
Make it stick
How can financing, dividends, growth and operating strategies change ratios, and what limits those comparisons?
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.