Compare ratio trends and assess their limitations
Use like-for-like periods and comparable businesses, then explain accounting and operating factors that limit conclusions.
Exam scope and assessment notes
Cambridge International AS & A Level Accounting 9706, 2026–2028 syllabus, Version 2. Use the ratio formulae in the syllabus appendix exactly; Cambridge states these are the only formulae accepted. Use year-end balances where appropriate unless the question specifies averages, and round to the requested number of decimal places. Practice is self-checked, not an official Cambridge grade. Full timed Papers 1–4 and human subject-teacher review remain outstanding.
Before you begin
- Use the AS Topic 1.6 ratio, financial-statement and stakeholder skills. These lessons add only the A Level ratios and interpretation required by Topic 3.5.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
A seasonal company has unusually low inventory on its year-end date. What should the analyst do?
What you will learn
- Compare ratios over time and with relevant peers
- Identify data, policy and one-off limitations
- Separate calculation from evaluation
Make comparisons like for like
Compare the same ratio, period length, accounting basis and business activity. A retailer and a manufacturer may have different inventory needs; seasonal businesses may show unusual year-end balances. Use year-end figures unless the question specifies averages, following the appendix instruction.
Check changes in credit policy, stock valuation, share issues, one-off profits, price movements and proposed dividends. A ratio can change because its numerator, denominator or accounting classification changed.
State what the evidence cannot show
Ratios simplify complex accounts and are based on historical or point-in-time figures. They do not show all cash timing, product quality, customer satisfaction, staff effects, future market conditions or management capability.
A sound evaluation calculates accurately, gives a supported interpretation, names a limitation and identifies further evidence. Avoid broad claims from one ratio or one reporting date.
Pause and explain
Which statement is best supported by a lower P/E alone?
Worked example
A company's dividend yield rises from 3% to 6%, but the dividend is unchanged. State the direct calculation cause and one limitation of calling this an improved return.
Show the worked solution
- With DPS unchanged, the market price must be lower for yield to double, all else equal.
- A price fall may reflect weaker expected performance or higher risk.
- Yield excludes price gains/losses and does not guarantee future dividends, so it is not the total return.
Answer Yield rose because price fell if DPS stayed fixed; this is not enough to call the investment more attractive.
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 manufacturer has a working-capital cycle of 70 days compared with a competitor's 45 days. Give two reasons the comparison may not be like for like.
Give me a hint
Check operating model, season, credit policy and calculation inputs.
Compare my reasoning
- The businesses may sell different goods with different inventory and production cycles.
- The reporting dates may fall in different seasonal periods or credit policies may differ.
- Confirm the exact turnover formulas, credit sales/purchases and average inventory treatment before drawing a conclusion.
Differences in product cycle, season and credit terms can explain part of the gap; verify comparable data before recommending changes.
Look for these in your work
- Identify business-model differences.
- Identify timing or policy differences.
- Check formulas and inputs before evaluating.
A firm's EPS falls 20% after it issues shares to fund expansion. What three questions help distinguish poor performance from investment timing?
Give me a hint
Compare profit, issued shares and project returns over an appropriate period.
Compare my reasoning
- How did total profit and operating performance change apart from the larger share count?
- When should the project begin to contribute profit and cash, and are current costs temporary?
- What financing costs, risks and future returns are expected, and how will progress be monitored?
Assess profit and share-count movements, project timing and expected returns before deciding whether the lower EPS signals weak underlying performance.
Look for these in your work
- Separate profit movement from the share-count effect.
- Check the project contribution timeline.
- Assess risk and expected return with follow-up measures.
A peer has a higher interest cover but recently sold a major operating asset. How should a lender use that comparison?
Give me a hint
The peer's one-off or reduced operating base may make the comparison misleading.
Compare my reasoning
- Identify whether the disposal gain or changed operations affect profit from operations.
- Recalculate or describe the impact using comparable recurring information only when supported by the data.
- Compare debt terms, cash flows, industry risks and the business model before treating the peer as a benchmark.
Qualify the peer comparison for disposal effects and operating changes, then assess recurring profit, cash flows and debt terms.
Look for these in your work
- Check whether a disposal distorts operating profit.
- Use comparable recurring information where available.
- Add cash-flow, debt and industry context.
Common mistakes
- Comparing unrelated business models without qualification
- Ignoring one-off items or changes in share count
- Calling a ratio the whole story
What can you explain now?
What should be checked before comparing two years' ratios?
Compare with the explanation
That periods and definitions are comparable
Like-for-like periods, accounting bases and business context support a fair comparison.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
List three limitations that should be considered when comparing accounting ratios.
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.