Level: HOTS (KBAT)
HOTS (KBAT) Worked Examples: Analysis and Interpretation of Financial Statements for Decision Making
Six KBAT examples of rising difficulty in which students calculate, interpret, correct errors and evaluate profitability, liquidity and efficiency ratios to make business decisions.
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Example 1: Profitability Ratios: Margin, Markup & Return on Capital
Question
Solution plan
Markup = Gross Profit / Cost of Sales × 100. Gross Profit Margin = Gross Profit / Sales × 100. Net Profit Margin = Net Profit / Sales × 100. Return on Capital = Net Profit / Capital × 100. The gap between the two margins reflects the weight of operating expenses.
| Item | Amount (RM) |
|---|---|
| Sales | 250,000 |
| Cost of Sales | 150,000 |
| Gross Profit | 100,000 |
| Net Profit | 40,000 |
| Capital | 200,000 |
| Ratio | Formula & Working | Result |
|---|---|---|
| Markup % | (100,000 ÷ 150,000) × 100 | 66.67% |
| Gross Profit Margin | (100,000 ÷ 250,000) × 100 | 40% |
| Net Profit Margin | (40,000 ÷ 250,000) × 100 | 16% |
| Return on Capital | (40,000 ÷ 200,000) × 100 | 20% |
The gap 40% − 16% = 24% is the operating-expense burden on sales.
Answer
Markup 66.67%, Gross Profit Margin 40%, Net Profit Margin 16%, Return on Capital 20%. The 24% gap between the margins shows operating expenses absorb more than half of gross profit; a 20% Return on Capital means every RM1 of capital earns 20 sen of net profit, which is satisfactory for a furniture retailer.
Where marks are usually lost
Example 2: Liquidity Ratios with a Stock-Value Correction
Question
Solution plan
Current Assets = Stock + Debtors + Cash. Current Liabilities = Creditors + Bank overdraft. Current Ratio = Current Assets / Current Liabilities. Acid-Test = (Current Assets − Stock) / Current Liabilities. The correction lowers only stock by RM4,000, so only Current Assets (and the Current Ratio) are affected; the Acid-Test excludes stock, so it is unchanged.
| Item | Amount (RM) |
|---|---|
| Closing stock | 24,000 |
| Debtors | 18,000 |
| Cash | 3,000 |
| Current Assets | 45,000 |
| Creditors | 15,000 |
| Bank overdraft | 10,000 |
| Current Liabilities | 25,000 |
| Ratio | Before (Stock 24,000) | After (Stock 20,000) |
|---|---|---|
| Current Assets (RM) | 45,000 | 41,000 |
| Current Ratio | 45,000 ÷ 25,000 = 1.8 : 1 | 41,000 ÷ 25,000 = 1.64 : 1 |
| Acid-Test Ratio | (45,000−24,000) ÷ 25,000 = 0.84 : 1 | (41,000−20,000) ÷ 25,000 = 0.84 : 1 |
The Acid-Test stays at 0.84 : 1 because stock is excluded from it, so the stock correction cannot affect it.
Answer
Before: Current Ratio 1.8 : 1, Acid-Test 0.84 : 1. After correction: Current Ratio falls to 1.64 : 1, Acid-Test unchanged at 0.84 : 1. The Acid-Test is unchanged because stock is already excluded from its formula. An Acid-Test below 1 : 1 warns that liquid assets cannot cover current liabilities.
Where marks are usually lost
Example 3: Efficiency Ratios: Stock Turnover, Collection & Payment
Question
Solution plan
Average Stock = (Opening + Closing) / 2. Stock Turnover = Cost of Sales / Average Stock. Debtor Collection Period = (Debtors / Credit sales) × 365. Creditor Payment Period = (Creditors / Credit purchases) × 365. Compare collection with payment to judge cash pressure.
| Ratio | Formula & Working | Result |
|---|---|---|
| Average Stock | (30,000 + 50,000) ÷ 2 | RM40,000 |
| Stock Turnover | 240,000 ÷ 40,000 | 6 times |
| Debtor Collection Period | (45,000 ÷ 360,000) × 365 | ≈ 46 days |
| Creditor Payment Period | (20,000 ÷ 260,000) × 365 | ≈ 28 days |
The business pays creditors (28 days) sooner than it collects from debtors (46 days), leaving an 18-day gap.
Answer
Stock Turnover is 6 times a year, Debtor Collection Period ≈ 46 days, Creditor Payment Period ≈ 28 days. Because the business pays creditors within 28 days but only collects within 46 days, there is an 18-day cash gap that can strain cash flow. Encik Faizal should tighten debtors' credit terms or negotiate longer supplier credit.
Where marks are usually lost
Example 4: Between-Period Comparison: Sales Up, Margins Down
Question
Solution plan
Compute Gross Profit Margin = Gross Profit / Sales × 100 and Net Profit Margin = Net Profit / Sales × 100 for each year. Compare the trend: sales rose, but if margins fell, profit per RM of sales has worsened. Evaluate causes (price discounting, higher purchase cost, higher operating expenses) and recommend measures.
| Item | 2023 (RM) | 2024 (RM) |
|---|---|---|
| Sales | 200,000 | 300,000 |
| Gross Profit | 80,000 | 105,000 |
| Net Profit | 30,000 | 36,000 |
| Ratio | 2023 | 2024 | Trend |
|---|---|---|---|
| Gross Profit Margin | 80,000÷200,000 = 40% | 105,000÷300,000 = 35% | Down 5 percentage points |
| Net Profit Margin | 30,000÷200,000 = 15% | 36,000÷300,000 = 12% | Down 3 percentage points |
Sales rose 50% (RM200,000 → RM300,000) yet both margins fell.
Answer
2023: Gross Profit Margin 40%, Net Profit Margin 15%. 2024: Gross Profit Margin 35%, Net Profit Margin 12%. Although sales grew 50%, both margins fell, so the quality of profit deteriorated rather than improved. The lower gross margin suggests price discounting or higher purchase costs; the net margin falling more slowly shows fairly good expense control. Recommendations: (1) negotiate lower purchase prices or reduce sales discounts to restore the gross margin; (2) control operating expenses (e.g. wages, utilities) so sales growth translates into net profit.
Where marks are usually lost
Example 5: Between-Business Comparison: Choose to Invest
Question
Solution plan
Compute the four ratios for each business. Net Profit Margin = Net Profit/Sales×100; Return on Capital = Net Profit/Capital×100; Current Ratio = Current Assets/Current Liabilities; Stock Turnover = Cost of Sales/Average Stock. The business with higher profitability, liquidity and efficiency is the better investment, even if its absolute sales are lower.
| Item | Indah (RM) | Ceria (RM) |
|---|---|---|
| Sales | 400,000 | 500,000 |
| Cost of Sales | 240,000 | 300,000 |
| Net Profit | 72,000 | 60,000 |
| Capital | 288,000 | 400,000 |
| Current Assets | 50,000 | 36,000 |
| Current Liabilities | 20,000 | 30,000 |
| Average Stock | 30,000 | 60,000 |
| Ratio | Indah | Ceria | Better |
|---|---|---|---|
| Net Profit Margin | 72,000÷400,000 = 18% | 60,000÷500,000 = 12% | Indah |
| Return on Capital | 72,000÷288,000 = 25% | 60,000÷400,000 = 15% | Indah |
| Current Ratio | 50,000÷20,000 = 2.5 : 1 | 36,000÷30,000 = 1.2 : 1 | Indah |
| Stock Turnover | 240,000÷30,000 = 8 times | 300,000÷60,000 = 5 times | Indah |
Ceria has higher sales (RM500,000) but is weaker on every ratio.
Answer
Kedai Pakaian Indah: Net Profit Margin 18%, Return on Capital 25%, Current Ratio 2.5 : 1, Stock Turnover 8 times. Kedai Pakaian Ceria: 12%, 15%, 1.2 : 1, 5 times. The better investment is Kedai Pakaian Indah because it beats Ceria on all four ratios: more profit per RM of sales, higher return on capital, stronger liquidity, and faster stock turnover. Although Ceria has larger sales, its performance quality is lower and its liquidity (1.2 : 1) is close to critical.
Where marks are usually lost
Example 6: Error Correction and Its Effect on the Ratios
Question
Solution plan
Error (1) adds RM10,000 to Purchases (and RM10,000 to Creditors), raising Cost of Sales. Error (2) reduces Closing stock by RM5,000, also raising Cost of Sales. Cost of Sales = Opening stock + Purchases − Closing stock. Gross Profit = Sales − Cost of Sales. Net Profit = Gross Profit − Expenses. The fall in net profit reduces closing capital by the same amount. Recompute margins and Return on Capital, then interpret.
| Item | Value |
|---|---|
| Cost of Sales (40,000+200,000−60,000) | RM180,000 |
| Gross Profit (300,000−180,000) | RM120,000 → 40% |
| Net Profit (120,000−70,000) | RM50,000 → 16.67% |
| Return on Capital (50,000÷250,000) | 20% |
| Item | RM | RM |
|---|---|---|
| Sales | 300,000 | |
| Opening stock | 40,000 | |
| Corrected purchases (200,000+10,000) | 210,000 | |
| Corrected closing stock (60,000−5,000) | -55,000 | |
| Cost of Sales | 195,000 | |
| Gross Profit | 105,000 | |
| Less: Expenses | -70,000 | |
| Net Profit | 35,000 | |
| Corrected closing capital (250,000−15,000) | 235,000 |
| Ratio | Original | Corrected |
|---|---|---|
| Gross Profit Margin | 120,000÷300,000 = 40% | 105,000÷300,000 = 35% |
| Net Profit Margin | 50,000÷300,000 = 16.67% | 35,000÷300,000 = 11.67% |
| Return on Capital | 50,000÷250,000 = 20% | 35,000÷235,000 = 14.89% |
Both errors raise Cost of Sales (RM15,000 in total), so every profitability ratio is lower than reported.
Answer
After correction: Cost of Sales RM195,000, Gross Profit RM105,000, Net Profit RM35,000, closing capital RM235,000. Corrected ratios: Gross Profit Margin 35% (was 40%), Net Profit Margin 11.67% (was 16.67%), Return on Capital 14.89% (was 20%). The original figures overstated profitability because the omitted purchases and overvalued stock wrongly lowered Cost of Sales. An investor relying on the original figures would think the business more profitable than it really is and might overpay or wrongly choose it: a distorted decision. The corrected ratios must be used before any decision is made.
Where marks are usually lost
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