What are the two profitability ratios?

The gross profit margin is gross profit over sales, expressed as a percentage, measuring the margin left after the cost of goods. The profit margin is profit for the year over sales, measuring the margin after all expenses, so it is always lower than the gross profit margin. Comparing the two is the key: a falling gross margin points to a trading problem, while a steady gross margin with a falling profit margin points to rising running expenses.

What are the two liquidity ratios?

The current ratio is current assets divided by current liabilities, showing whether the business can pay its short-term debts. The quick (acid-test) ratio does the same but excludes inventory, the least liquid current asset, so it is the stricter test. A current ratio near 2:1 and a quick ratio near 1:1 are often seen as comfortable, but the right level depends on the business.

Why must ratios be compared?

A single ratio means little on its own. It becomes useful only when compared against a previous year, a budget, or another similar business, so you can judge whether performance is improving, holding steady, or worsening. Comparison turns a bare number into a story you can explain, which is what N(A)-Level questions reward.

What are the limitations of ratio analysis?

Ratios use past figures, so they may not predict the future; they ignore non-financial factors such as staff quality, location and reputation; they can be distorted by one-off events or different accounting choices; and comparing businesses of different sizes or in different industries can mislead. Ratios point to questions worth asking, not final answers.

Is a higher current ratio always better?

No. A very high current ratio can mean resources are idle: too much inventory tying up cash, slow-paying customers swelling receivables, or cash sitting in the bank earning nothing. The business might use those resources more profitably. A healthy ratio strikes a balance between being able to pay debts and not leaving resources unused.

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Financial analysis and ratios: N(A)-Level Principles of Accounts (SEAB 7086), covering profitability ratios, liquidity ratios, and interpreting and comparing ratios with their limitations

An N(A)-Level Principles of Accounts (SEAB 7086) overview of financial analysis and ratios: the gross profit margin and profit margin, the current ratio and the quick (acid-test) ratio, and how to interpret ratios by comparison while keeping in mind the limitations of ratio analysis.

Generated by Claude Opus 4.87 min readSEAB-7086Updated 2026-06-13

Reviewed by: AI editorial process; not yet individually human-reviewed

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What this module trains
Profitability ratios
Liquidity ratios
Interpreting and comparing ratios
Check your knowledge

What this module trains

The financial statements show the numbers; ratios make sense of them. N(A)-Level Principles of Accounts (SEAB 7086) asks you to calculate a small set of profitability and liquidity ratios, then interpret them by comparison and explain the limits of doing so. This module is short but high value, because it rewards clear reasoning as much as calculation.

This guide links the three dot points of the module, each with its own page and practice, and builds on the financial statements the ratios are drawn from. The subject hub is at /sg-n-level/accounting and the syllabus index at /sg-n-level/accounting/syllabus.

Profitability ratios

The profitability ratios dot point covers the gross profit margin and the profit margin:

\text{Gross profit margin} = \frac{\text{gross profit}}{\text{sales}} \times 100\%, \qquad \text{Profit margin} = \frac{\text{profit for the year}}{\text{sales}} \times 100\%.

Comparing the two tells you whether a fall in profit comes from the cost of goods (the gross margin) or from running expenses (the gap between the two margins).

Liquidity ratios

The liquidity ratios dot point covers the current ratio and the quick (acid-test) ratio:

\text{Current ratio} = \frac{\text{current assets}}{\text{current liabilities}}, \qquad \text{Quick ratio} = \frac{\text{current assets} - \text{inventory}}{\text{current liabilities}}.

The quick ratio is stricter because it leaves out inventory, the hardest current asset to turn into cash quickly.

Interpreting and comparing ratios

The interpreting and comparing ratios dot point shows why a ratio must be compared (against last year, a budget, or another business) and lists the limitations of ratio analysis, including that ratios use past data and ignore non-financial factors.

Calculating and interpreting ratios

step 1: calculate the profitability ratios

Sales $\text{S\textdollar}100{,}000$ ; gross profit $\text{S\textdollar}40{,}000$ ; profit for the year $\text{S\textdollar}15{,}000$ .
Gross profit margin $= \dfrac{\text{S\textdollar}40{,}000}{\text{S\textdollar}100{,}000} \times 100\% = 40\%$ . Profit margin $= \dfrac{\text{S\textdollar}15{,}000}{\text{S\textdollar}100{,}000} \times 100\% = 15\%$ .

step 2: calculate the liquidity ratios

Current assets $\text{S\textdollar}30{,}000$ (including inventory $\text{S\textdollar}12{,}000$ ); current liabilities $\text{S\textdollar}15{,}000$ .
Current ratio $= \dfrac{\text{S\textdollar}30{,}000}{\text{S\textdollar}15{,}000} = 2\!:\!1$ . Quick ratio $= \dfrac{\text{S\textdollar}30{,}000 - \text{S\textdollar}12{,}000}{\text{S\textdollar}15{,}000} = \dfrac{\text{S\textdollar}18{,}000}{\text{S\textdollar}15{,}000} = 1.2\!:\!1$ .

step 3: interpret by comparison

Last year the gross margin was also $40\%$ but the profit margin was $20\%$ . The gross margin held, yet the profit margin fell from $20\%$ to $15\%$ , so running expenses have risen rather than the cost of goods.

step 4: state a limitation

This judgement rests on past figures and ignores non-financial factors, such as a new shop opening that pushed up expenses now but may raise sales later, so the ratios point to a question rather than a final verdict.

Check your knowledge

A mix of calculation and interpretation questions across the module. Work each fully, then check against the solutions.

Sales are $\text{S\textdollar}80{,}000$ and gross profit is $\text{S\textdollar}32{,}000$ . Calculate the gross profit margin. (2 marks)
Sales are $\text{S\textdollar}80{,}000$ and profit for the year is $\text{S\textdollar}12{,}000$ . Calculate the profit margin. (2 marks)
Current assets are $\text{S\textdollar}24{,}000$ and current liabilities are $\text{S\textdollar}12{,}000$ . Calculate the current ratio. (2 marks)
Current assets are $\text{S\textdollar}24{,}000$ (including inventory $\text{S\textdollar}9{,}000$ ) and current liabilities are $\text{S\textdollar}12{,}000$ . Calculate the quick ratio. (2 marks)
The gross margin is unchanged but the profit margin has fallen. Suggest what has happened. (2 marks)
State two limitations of ratio analysis. (2 marks)

Solutions

Q1: Gross profit margin $= \dfrac{\text{S\textdollar}32{,}000}{\text{S\textdollar}80{,}000} \times 100\% = 40\%$ .
Q2: Profit margin $= \dfrac{\text{S\textdollar}12{,}000}{\text{S\textdollar}80{,}000} \times 100\% = 15\%$ .
Q3: Current ratio $= \dfrac{\text{S\textdollar}24{,}000}{\text{S\textdollar}12{,}000} = 2\!:\!1$ .
Q4: Quick ratio $= \dfrac{\text{S\textdollar}24{,}000 - \text{S\textdollar}9{,}000}{\text{S\textdollar}12{,}000} = \dfrac{\text{S\textdollar}15{,}000}{\text{S\textdollar}12{,}000} = 1.25\!:\!1$ .
Q5: The cost of goods relative to sales is steady (the gross margin held), so the fall in the profit margin must come from higher running expenses, such as wages, rent or depreciation.
Q6: Any two of: ratios use past figures and may not predict the future; they ignore non-financial factors such as staff quality or location; they can be distorted by one-off events; comparisons across different sizes or industries can mislead.

Sources & how we know this

Principles of Accounts (Syllabus 7086) — Singapore Examinations and Assessment Board (2026)