Financial Data
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Financial Ratio Analysis Guide for European Auditors — free PDF
ISA 520 & ISA 570 practical workbook: all formulas with visual explanations, industry benchmark reference tables from BACH for 15 industries, ratio interpretation guide, and template narrative paragraphs for audit working papers.
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ISA 520.5 — Design and perform analytical procedures near the end of the audit that assist in forming an overall conclusion.
ISA 520.A1 — Analytical procedures may include ratios such as gross margin percentages and ratio of sales to accounts receivable.
ISA 570.A3 — Negative working capital, adverse key financial ratios, operating losses, and other indicators may cast doubt on going concern.
Financial Ratio Analysis: Complete Methodology
Financial ratio analysis transforms raw financial statement data into meaningful indicators of an entity's financial health, operational efficiency, and solvency risk. For auditors performing analytical procedures under ISA 520, ratio analysis provides the quantitative foundation for establishing expectations, identifying unusual fluctuations, and substantiating the overall audit conclusion. ISA 520.A1 explicitly names gross margin percentages and the ratio of sales to accounts receivable as examples of analytical procedures, but the full toolkit extends to more than thirty distinct ratios across four categories: liquidity, profitability, leverage, and activity.
Liquidity Ratios
Liquidity ratios measure an entity's ability to meet short-term obligations as they fall due. The current ratio (Current Assets / Current Liabilities) provides the broadest measure of short-term financial health — a ratio below 1.0 indicates the entity cannot cover its current liabilities from current assets, which ISA 570.A3 lists as a going concern indicator. The quick ratio is more stringent, excluding inventory and prepaid expenses that may not be readily convertible to cash. The cash ratio considers only the most liquid assets: cash and marketable securities. Working capital (Current Assets − Current Liabilities) provides the absolute euro-denominated liquidity position, which is critical for covenant compliance testing and going concern assessment.
Profitability Ratios
Profitability ratios assess the entity's ability to generate returns from its revenue, assets, and equity base. Gross margin ((Revenue − COGS) / Revenue × 100) reveals pricing power and cost efficiency at the product/service level — ISA 520.A1 specifically identifies this as an analytical procedure. Net margin (Net Income / Revenue × 100) captures the bottom-line efficiency after all expenses. ROE (Net Income / Total Equity × 100) measures the return generated on shareholders' investment, while ROA (Net Income / Total Assets × 100) measures how efficiently the entity deploys its asset base. ROIC (NOPAT / Invested Capital × 100) provides a capital-structure-neutral view of operational returns, useful for comparing companies with different financing strategies. EBITDA margin (EBITDA / Revenue × 100) strips out financing, depreciation, and tax effects to reveal core operational profitability.
Leverage Ratios
Leverage ratios quantify the entity's dependence on debt financing and its capacity to service that debt. The debt-to-equity ratio (Total Liabilities / Total Equity) indicates how much of the entity's capital structure comes from creditors versus shareholders — a ratio exceeding 3.0x suggests high financial risk for most industries. The debt-to-assets ratio (Total Liabilities / Total Assets) shows the proportion of assets financed by debt. Interest coverage (EBIT / Interest Expense) measures the entity's ability to pay interest from operating profits — a ratio below 1.5x signals limited debt-servicing capacity and is a going concern indicator under ISA 570. Debt service coverage (EBITDA / (Interest + Principal Repayments)) extends this to include principal repayments, providing a more comprehensive view of the entity's ability to meet all debt obligations. The equity multiplier (Total Assets / Total Equity) shows the degree of financial leverage.
Activity Ratios
Activity ratios measure how efficiently the entity manages its working capital components. Inventory turnover (COGS / Average Inventory) and inventory days (365 / Inventory Turnover) reveal whether stock is moving efficiently or accumulating. Days Sales Outstanding (DSO) measures how quickly the entity collects receivables — ISA 520.A2 names this as a key analytical procedure. Days Payable Outstanding (DPO) shows the average payment period to suppliers, reflecting negotiating power and cash management. Asset turnover (Revenue / Total Assets) indicates overall asset efficiency. The cash conversion cycle (DSO + Inventory Days − DPO) synthesises these into a single measure of working capital efficiency — a longer cycle means more cash is tied up in operations.
Altman Z-Score: Going Concern Assessment
The Altman Z-Score is a multivariate discriminant model that predicts the probability of bankruptcy using five financial ratios. Three variants exist for different entity types. The Original Z-Score (Z = 1.2×WC/TA + 1.4×RE/TA + 3.3×EBIT/TA + 0.6×MVE/TL + 1.0×Sales/TA) was developed for publicly traded manufacturing companies and uses market value of equity. The Z'-Score for private companies substitutes book value of equity for market value and adjusts the coefficients (Z' = 0.717×X1 + 0.847×X2 + 3.107×X3 + 0.420×BVE/TL + 0.998×X5). The Z''-Score for non-manufacturing and services companies removes asset turnover entirely (Z'' = 6.56×X1 + 3.26×X2 + 6.72×X3 + 1.05×BVE/TL) because this ratio varies dramatically by industry. Each variant has different zone thresholds: the original uses 2.99 (safe) and 1.81 (distress), while the services variant uses 2.60 and 1.10 respectively. The Z-Score is explicitly not applicable to banks and insurance companies.
ISA 520: Analytical Procedures in Practice
ISA 520 requires the auditor to design and perform analytical procedures near the end of the audit that assist in forming an overall conclusion as to whether the financial statements are consistent with the auditor's understanding of the entity. ISA 520.A1–A2 provides examples including gross margin percentages and the ratio of sales to accounts receivable. The standard requires auditors to develop an expectation (using industry benchmarks, prior year ratios, or budgeted figures), compare the actual ratio to the expectation, and investigate significant differences. This calculator supports all three steps: it computes the actual ratios, provides European BACH industry benchmarks as the expectation baseline, and highlights deviations through RAG colour coding.
ISA 570: Going Concern Indicators
ISA 570.A3 lists specific events and conditions that, individually or collectively, may cast significant doubt about an entity's ability to continue as a going concern. The financial indicators include: negative net current assets (working capital), adverse key financial ratios, substantial operating losses, arrears or discontinuance of dividends, inability to pay creditors on due dates, inability to comply with the terms of loan agreements, and change from credit to cash-on-delivery transactions with suppliers. This calculator checks the quantitative indicators automatically and presents them as a binary checklist. However, the auditor must exercise professional judgment: a single triggered indicator does not automatically mean going concern doubt exists, and mitigating factors (available credit facilities, management plans, asset disposal options) must be considered.
BACH Benchmark Data
The BACH database (Bank for the Accounts of Companies Harmonized), accessible at bach.banque-france.fr, is a free resource maintained by the European Committee of Central Balance-Sheet Data Offices (ECCBSO) under ECB sponsorship. It provides aggregated financial ratios covering 12 European countries, broken down by NACE sector code, company size class, and country. Each ratio is reported with Q1 (25th percentile), median (50th percentile), and Q3 (75th percentile) values. This calculator embeds pre-extracted BACH data for 14 industries, updated annually. Benchmarks should be interpreted as European averages — individual country conditions, company size, and subsector specialisation may result in legitimate deviations.
Worked Example: Mid-Size European Manufacturer
Entity: EuroTech GmbH — industrial equipment manufacturer with €45M revenue, €31.5M COGS, €4.05M EBIT, €2.7M net income, €18M current assets, €11M current liabilities, €42M total assets, €24M total liabilities, €18M total equity, €8.5M inventory, €5.2M accounts receivable, €12M retained earnings, and €900K interest expense.
Key results: Current Ratio of 1.64 (above BACH manufacturing median of 1.55 — adequate liquidity). Quick Ratio of 0.86 (below median of 1.05 — inventory-dependent liquidity, typical for manufacturers). Gross Margin of 30.0% (close to BACH median of 32.0%). Net Margin of 6.0% (above median of 4.5% — healthy profitability). ROE of 15.0% (above median of 12.0%). Debt-to-Equity of 1.33 (above median of 1.05 — moderately leveraged). Interest Coverage of 4.5x (below median of 5.5x but adequate). Inventory Days of 98 (above Q3 of 105 — warrants investigation into slow-moving stock). The Altman Z'-Score of 2.45 falls in the Grey Zone, warranting further investigation despite the generally healthy ratio profile. No ISA 570 going concern indicators were triggered.
Audit conclusion: The ratio analysis supports a broadly healthy financial position. The inventory days metric exceeding the industry Q3 benchmark should be investigated through detailed aged inventory analysis. The Z-Score Grey Zone reading is driven by the moderate leverage position and should be considered alongside qualitative factors including the entity's order backlog, customer diversification, and bank relationship.