Ratios compress a set of accounts into a few numbers, and that compression hides a lot. They rely on a single year end snapshot that can be dressed up, on accounting policies that differ between businesses and change over time, on formulas that are not standardised, and on book values that may bear little relation to what assets are worth or what they cost to replace. Used without the context behind them, ratios can point firmly in the wrong direction.

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Why can a ratio mislead even when the arithmetic is right?

A ratio is only as good as the two figures that make it up, and each figure is the product of judgements, timing and accounting choices. ACCA’s examining team, writing on financial statements interpretation, complains that candidates state facts such as “gross profit margin has increased” without explaining why. A movement in a ratio is a question, not an answer. The rest of this page sets out the main reasons a ratio can tell the wrong story; the individual ratios are covered in pages such as gearing, current and quick ratios and asset turnover.

How does window dressing distort year end ratios?

Balance sheet ratios are measured at one date. Window dressing means arranging transactions around that date so the position looks better than it usually is. Common forms include:

  • paying suppliers just before the year end out of cash, which can lift a current ratio that is above 1, or delaying payments to keep cash high;
  • running stock down or chasing debtors hard in the last weeks, then letting both drift back;
  • factoring debts or selling and leasing back assets to bring in cash;
  • borrowing short term just before the year end and repaying just after.

HMRC’s International Manual at INTM516070, describing how lenders view cash flow, lists ways a company can augment its cash flow: factoring receivables, delaying payment to creditors, reducing trading stock and sale and leaseback, the last at the expense of future cash flow. Each is legitimate in itself, but if done for the year end they make a single balance sheet unrepresentative.

Accounting standards limit some techniques. FRS 102 paragraph 2.96 prohibits offsetting assets and liabilities, or income and expenses, unless required or permitted, so cash cannot simply be netted against a loan to improve gearing. But standards cannot stop real transactions timed for the year end. ACCA’s working capital article notes that exam questions often use year end inventory, receivables and payables as a proxy for the average; in practice an average of monthly balances, where available, is a better basis.

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How do different accounting policies affect comparisons?

FRS 102 paragraph 2.20 says comparability is diminished when alternative accounting methods are applied to the same economic phenomena. Several policy choices go straight to common ratios:

Policy choice FRS 102 reference Ratios affected
Cost or revaluation model for property, plant and equipment Paragraph 17.15 ROCE, asset turnover, gearing
Capitalise or expense borrowing costs on qualifying assets Paragraph 25.2 Interest cover, operating margin
Lease accounting before and after the 2026 amendments Paragraphs 20.45 and 1.37 Gearing, current ratio, asset turnover, EBITDA

ACCA’s FR article explains that a revaluation increases capital employed and reduces asset turnover and ROCE without any real change in capacity or profitability. A company that revalues its property will look less efficient than an otherwise identical one that keeps it at cost. Estimates matter as well: depreciation lives, bad debt provisions and stock write downs all differ between preparers. See accounting policies, estimates and errors.

What happens when the accounting rules change?

Changes in standards can move ratios overnight. The IASB’s effects analysis for IFRS 16 predicted that putting leases on the balance sheet would increase gearing, decrease the current ratio and asset turnover, and increase EBITDA. FRS 102 now follows a similar model, with a lessee recognising a right of use asset and lease liability for accounting periods beginning on or after 1 January 2026. Any trend that spans the change needs restating, or it will show a deterioration in gearing that is purely presentational. Lenders deal with this through “frozen GAAP” clauses, which INTM515070 describes as reinstating the accounting basis on which covenants were agreed. For IFRS reporters, IFRS 18 introduces new required subtotals from 1 January 2027, which will change what “operating profit” means in some accounts. See IFRS 18.

Do one off events and timing distort the picture?

Yes. ACCA’s FR article gives several examples: a gain on disposal inflates operating margin and the disposal shrinks the asset base, improving asset turnover and ROCE; a large asset bought late in the year depresses ROCE because it has not contributed a full year’s profit. ACCA suggests recalculating ratios without the one off item to restore comparability. HMRC’s guidance at INTM515060 takes a similar line on restructuring costs, accepting that temporary costs may be disregarded but warning that costs recurring for several years should not be ignored.

Why do sector and size comparisons often fail?

Norms differ sharply between industries. ACCA says acceptable current ratios vary by sector and many companies operate safely below 2:1; its working capital article notes that a current ratio below 1 can be typical in retail, particularly supermarkets, while traditional manufacturers may be expected to show 2 or more. ACCA also says levels of gearing vary enormously between industries. Comparing a business with a broad average from a different sector, or a different size band, says more about the sector than the business.

Data is another constraint. Under section 444 of the Companies Act 2006, the directors of a company subject to the small companies regime must file a balance sheet but may choose whether to file the profit and loss account. Public records for many private companies therefore do not support profitability ratios at all.

Are ratios built on book values reliable?

Book values are historical. ACCA’s performance measurement article notes that where assets are measured at net book value, return measures generally improve as assets age, which can encourage managers to keep outdated plant rather than invest. The same article points out that return on investment is a relative measure, so it can favour a small high percentage project over a larger one that creates more value, and that single figure measures can overemphasise short term performance. Intangible strengths such as staff skills, customer relationships and internally generated brands often do not appear on the balance sheet at all.

Do different formulas for the same ratio cause problems?

Frequently. ACCA notes that many definitions of gearing exist. Capital employed can be total assets less current liabilities or debt plus equity. Interest cover can use EBIT or EBITDA, and gross or net interest. HMRC’s worked example at INTM516040 shows interest cover of 2.6 on gross interest payable rising to 3.9 when interest receivable is netted off, from the same accounts. Always state the formula used, and make sure any benchmark uses the same one.

How should ratios be used well?

  • Look at trends over several years, not a single figure.
  • Read the accounting policies note before comparing businesses.
  • Strip out one off items and recalculate.
  • Check cash: ACCA notes a healthy operating cash flow will often compensate for weak liquidity ratios. See the cash flow statement.
  • Combine ratios, such as margin with asset turnover, rather than reading one alone.
  • Ask what happened in the business. The numbers should support a story that management can explain.

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Reviewed by Christine Anderson, Broker, Solar Protect. Last reviewed 8 October 2026. Part of Accountapedia, the Solar Protect guide to UK tax and accounting. This page is general information, not personalised advice.