Formula and Ratio Revision Page
- andresalyza123
- Jun 30
- 7 min read
HSC Business Studies | Free Study Notes
The Formula and Ratio Revision Page helps you revise the key financial ratios used in HSC Business Studies. These formulas are important because they allow you to calculate, interpret and evaluate business performance using financial data.
In this lesson
how to calculate the current ratio
how to calculate gearing using the debt to equity ratio
how to calculate profitability ratios
how to calculate the expense ratio
how to calculate the accounts receivable turnover ratio
Core notes
Why financial ratios matter
Financial ratios help a business analyse its financial performance. They turn raw financial data into useful information that can be compared over time, against objectives or against industry benchmarks.
In HSC Business Studies, ratios are often used to assess:
liquidity
solvency
profitability
efficiency
A strong answer should not only calculate the ratio. You also need to explain what the result means for the business.
For more exam practice, revise finance case study practice [Finance Case Study Practice].
Current ratio
What the current ratio measures
The current ratio measures liquidity. Liquidity is the ability of a business to meet its short-term financial obligations.
Formula
Current ratio = current assets ÷ current liabilities
It is usually written as a ratio, such as:
2:1
How to interpret the current ratio
A current ratio of 2:1 means the business has $2 of current assets for every $1 of current liabilities.
A higher current ratio may suggest the business can meet short-term debts more easily. However, a very high current ratio may also suggest that the business has too much money tied up in current assets, such as inventory or cash, rather than using it productively.
Example
If a business has:
current assets = $200 000
current liabilities = $100 000
Current ratio = 200 000 ÷ 100 000Current ratio = 2:1
This means the business has twice as many current assets as current liabilities.
For related content, revise working capital management [Working Capital Management].
Debt to equity ratio
What the debt to equity ratio measures
The debt to equity ratio measures gearing. Gearing shows the relationship between borrowed funds and owner’s equity.
It is used to assess solvency and financial risk.
Formula
Debt to equity ratio = total liabilities ÷ owner’s equity
It is usually written as a ratio, such as:
1.5:1
How to interpret the debt to equity ratio
A higher debt to equity ratio means the business relies more heavily on debt. This may increase financial risk because the business must make repayments and may have higher interest costs.
A lower debt to equity ratio means the business relies more on equity. This may reduce risk, but it can also limit growth if the business does not have enough funds to expand.
Example
If a business has:
total liabilities = $300 000
owner’s equity = $200 000
Debt to equity ratio = 300 000 ÷ 200 000Debt to equity ratio = 1.5:1
This means the business has $1.50 of debt for every $1 of owner’s equity.
Gross profit ratio
What the gross profit ratio measures
The gross profit ratio measures profitability before expenses are deducted. It shows how much gross profit is made from sales.
Formula
Gross profit ratio = gross profit ÷ sales × 100
It is written as a percentage.
How to interpret the gross profit ratio
A higher gross profit ratio suggests the business is making more gross profit from each dollar of sales. This may be due to higher selling prices, lower cost of goods sold or better control over production costs.
A lower gross profit ratio may suggest that cost of goods sold is too high or that the business is selling products at low margins.
Example
If a business has:
gross profit = $80 000
sales = $200 000
Gross profit ratio = 80 000 ÷ 200 000 × 100Gross profit ratio = 40%
This means 40% of sales revenue remains as gross profit before expenses are deducted.
Net profit ratio
What the net profit ratio measures
The net profit ratio measures profitability after expenses are deducted. It shows how much net profit is made from sales.
Formula
Net profit ratio = net profit ÷ sales × 100
It is written as a percentage.
How to interpret the net profit ratio
A higher net profit ratio means the business keeps more profit from each dollar of sales after paying expenses.
A lower net profit ratio may suggest:
expenses are too high
sales revenue is too low
cost controls are weak
the business is operating inefficiently
Example
If a business has:
net profit = $50 000
sales = $200 000
Net profit ratio = 50 000 ÷ 200 000 × 100Net profit ratio = 25%
This means the business keeps 25 cents as net profit for every $1 of sales.
For strategies to improve profitability, revise profitability management [Profitability Management].
Return on equity
What return on equity measures
Return on equity measures how effectively a business uses owner’s equity to generate profit.
It is a profitability ratio.
Formula
Return on equity = net profit ÷ owner’s equity × 100
It is written as a percentage.
How to interpret return on equity
A higher return on equity means the business is generating more profit from the owner’s investment.
A lower return on equity may suggest that the business is not using owner’s funds efficiently.
Example
If a business has:
net profit = $60 000
owner’s equity = $300 000
Return on equity = 60 000 ÷ 300 000 × 100Return on equity = 20%
This means the business generated a 20% return on the owner’s equity.
Expense ratio
What the expense ratio measures
The expense ratio measures the proportion of sales used to pay expenses. It helps a business assess expense control.
Formula
Expense ratio = total expenses ÷ sales × 100
It is written as a percentage.
How to interpret the expense ratio
A lower expense ratio usually suggests better expense control.
A higher expense ratio may indicate that expenses are taking up too much of sales revenue, which can reduce net profit.
Example
If a business has:
total expenses = $120 000
sales = $300 000
Expense ratio = 120 000 ÷ 300 000 × 100Expense ratio = 40%
This means 40% of sales revenue is being used to pay expenses.
Accounts receivable turnover ratio
What the accounts receivable turnover ratio measures
The accounts receivable turnover ratio measures how efficiently a business collects money from credit customers.
It is an efficiency ratio.
Formula
Accounts receivable turnover ratio = sales ÷ accounts receivable
It can also be used to estimate the average collection period:
Average collection period = 365 ÷ accounts receivable turnover ratio
How to interpret the accounts receivable turnover ratio
A higher turnover ratio means the business is collecting debts more quickly.
A lower turnover ratio may suggest customers are taking too long to pay, which can create cash flow problems.
Example
If a business has:
sales = $500 000
accounts receivable = $50 000
Accounts receivable turnover ratio = 500 000 ÷ 50 000Accounts receivable turnover ratio = 10 times
Average collection period = 365 ÷ 10Average collection period = 36.5 days
This means the business collects accounts receivable about every 37 days on average.
For strategies linked to cash flow, revise cash flow management [Cash Flow Management].
How to write about ratios in exam answers
Step 1: Calculate the ratio
Show your working clearly. This helps the marker see your method, even if your final answer has a small error.
Step 2: State what the ratio means
Do not leave the answer as just a number. Explain what it shows about the business.
For example:
“The current ratio is 2:1, meaning the business has $2 of current assets for every $1 of current liabilities.”
Step 3: Link to business performance
Explain whether the result is positive, negative or needs more information.
For example:
“This suggests the business has strong liquidity and should be able to meet short-term debts. However, the business should also check whether too much cash or inventory is being held unproductively.”
Step 4: Suggest a strategy if asked
If the question asks for a recommendation, link the ratio to a strategy.
For example:
“If the business has a weak current ratio, it could improve liquidity by reducing inventory levels, collecting accounts receivable more quickly or negotiating longer payment terms with suppliers.”
Worked example
Exam-style question
A business has the following financial information:
sales = $400 000
cost of goods sold = $250 000
total expenses = $100 000
Calculate the gross profit ratio and net profit ratio.
Step 1: Calculate gross profit
Gross profit = sales − cost of goods soldGross profit = 400 000 − 250 000Gross profit = $150 000
Step 2: Calculate gross profit ratio
Gross profit ratio = gross profit ÷ sales × 100Gross profit ratio = 150 000 ÷ 400 000 × 100Gross profit ratio = 37.5%
Step 3: Calculate net profit
Net profit = gross profit − total expensesNet profit = 150 000 − 100 000Net profit = $50 000
Step 4: Calculate net profit ratio
Net profit ratio = net profit ÷ sales × 100Net profit ratio = 50 000 ÷ 400 000 × 100Net profit ratio = 12.5%
Sample interpretation
The business has a gross profit ratio of 37.5%, meaning it keeps 37.5% of sales as gross profit after cost of goods sold. Its net profit ratio is 12.5%, meaning it keeps 12.5% of sales as net profit after expenses. The gap between the two ratios suggests expenses have a significant impact on final profitability.
Common mistakes
Forgetting to multiply percentage ratios by 100.
Mixing up gross profit and net profit.
Using total liabilities instead of current liabilities in the current ratio.
Writing a ratio as a percentage when it should be shown as a ratio.
Calculating ratios correctly but not interpreting what they mean.
Forgetting to link ratio results to business performance.
Rounding too early and getting a less accurate final answer.
Quick quiz
What does the current ratio measure?
Which ratio is used to assess gearing?
What is the formula for the gross profit ratio?
Why is the net profit ratio usually lower than the gross profit ratio?
What does the accounts receivable turnover ratio show about a business?
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