Write justified recommendations from ratio analysis
Turn calculations into stakeholder-specific advice supported by ratio evidence, trade-offs and further checks.
Section 3.5 · Analysis and communication of accounting information
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
Which measures are most directly relevant to a shareholder comparing income return?
What you will learn
- Select ratios relevant to the stakeholder's decision
- Support advice with calculated data and balanced reasons
- State uncertainty and identify evidence to monitor
Choose evidence that answers the decision
A lender may focus on gearing, interest cover, cash flow and repayment terms. An ordinary shareholder may consider EPS, P/E, DPS, yield and dividend cover. Managers may examine the working capital cycle and net working assets relative to revenue.
Use the ratios that match the decision rather than repeating every calculation. Quote the actual result, compare it with a relevant period or benchmark and explain what changed in the underlying accounts.
Build a justified and balanced recommendation
A strong recommendation states an action, supports it with relevant evidence, considers a counterargument or cost and explains a condition or next check. Avoid saying that one number proves a business is safe, successful or undervalued.
Use a stakeholder's time horizon and objectives. A short-term shareholder seeking income and a lender assessing repayment capacity do not need identical advice. Identify risks and non-financial factors that the ratios do not capture.
Pause and explain
What is a useful limitation to include in a lender recommendation?
Worked example
A company has a 75-day cycle, interest cover of 2 times and gearing of 50%. A lender asks whether to extend credit. Outline a justified response.
Show the worked solution
- The 75-day cycle may tie up cash, while 2-times cover leaves less operating-profit headroom than a higher cover would.
- Gearing of 50% shows half of defined total capital is non-current liabilities under the appendix formula, but it does not by itself decide creditworthiness.
- Request cash forecasts, debt maturities, covenant headroom and a plan to manage working capital before recommending terms.
Answer The ratios identify questions about cash and debt risk; an extension should depend on cash-flow and repayment evidence, not on one threshold.
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 shareholder's EPS is 30 cents, DPS is 12 cents, yield is 4% and cover is 2.5 times. Write one balanced sentence about income and sustainability.
Give me a hint
Use both the investor return and the profit buffer, then qualify cash and future policy.
Compare my reasoning
- DPS of 12 cents and 4% yield describe the current per-share distribution relative to price.
- Cover of 2.5 times means profit available is 2.5 times the annual dividend in the figures.
- State that cash flows, investment plans and proposal status are still needed to judge sustainability.
The dividend offers a 4% yield and is covered 2.5 times by stated profit, but cash needs, investment plans and approval still matter.
Look for these in your work
- Use the stated dividend and yield.
- Interpret cover as a times measure.
- Qualify sustainability with cash and investment evidence.
A manager's working capital cycle rises 18 days while net working assets to revenue rises from 10% to 16%. Give a recommendation structure with two evidence checks.
Give me a hint
Connect the longer cycle and larger working-capital share, then look at components and service effects.
Compare my reasoning
- State that more time and a larger share of sales may be tied up in the defined working assets.
- Check receivable ageing, stock levels/stock-outs, payables terms and sales movement to locate the driver.
- Recommend a targeted action only after checking service, customer and supplier effects; monitor the affected component ratios.
Investigate the components before acting. Target the cause and monitor cash release alongside service and supplier outcomes.
Look for these in your work
- Cite both ratio movements.
- Identify component-level evidence to request.
- Balance cash impact with operating relationships.
A board must choose between a larger proposed dividend and retaining funds for a project. EPS is 28 cents, DPS would rise to 20 cents, cover would fall to 1.4 times and project returns are uncertain. Advise what the board should evaluate.
Give me a hint
Compare shareholder income with coverage, cash needs, project evidence and risk.
Compare my reasoning
- Calculate or verify DPS, yield and cover using the appendix formulae and the relevant market price and profit data.
- Review cash forecasts, debt commitments and the project's expected cash flows, risks and alternative funding.
- Compare the investor-income benefit with the project's opportunity cost and resilience; make the recommendation conditional on reliable evidence and monitor outcomes.
The board should assess the dividend's 1.4-times profit cover alongside cash and debt needs and test the uncertain project returns. A decision should explain the shareholder trade-off and be based on realistic forecasts.
Look for these in your work
- Use the exact investment and dividend formulae.
- Check cash, debt and project evidence.
- Explain trade-offs and uncertainty in the recommendation.
Common mistakes
- Giving advice without citing a result
- Ignoring a counterargument or cost
- Using ratios outside their defined meaning
What can you explain now?
What makes a recommendation justified?
Compare with the explanation
Relevant results, reasons, trade-offs and supporting evidence
Advice should connect accurate analysis with a decision, balanced reasoning and relevant evidence.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
Give a four-part structure for an evidence-based recommendation from ratio analysis.
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.