Financial Ratio Calculator
United Kingdom

Financial Ratio Analysis in United Kingdom — ISA (UK) 520 / ISA (UK) 570

Financial ratio analysis forms a cornerstone of analytical procedures under ISA (UK) 520, which requires auditors to design and perform substantive analytical procedures that are suitable for the purpose. In the United Kingdom, the Financial Reporting Council has established clear expectations for how auditors should apply ratio analysis as part of both planning analytics and substantive testing. The FRC's Audit Quality Review team consistently emphasises that analytical procedures should not be a mechanical exercise but rather a thoughtful evaluation of financial relationships, grounded in the auditor's understanding of the entity and its environment. UK auditors must consider industry-specific benchmarks, macroeconomic conditions, and entity-specific factors when setting expectations for financial ratios, and must investigate significant deviations with appropriate professional scepticism.

Regulatory Context — FRC

The FRC's thematic reviews have repeatedly highlighted analytical procedures as an area requiring improvement in UK audit quality. ISA (UK) 520 requires that when analytical procedures identify fluctuations or relationships inconsistent with other relevant information or that differ from expected values by a significant amount, the auditor shall investigate such differences by making inquiries of management and obtaining appropriate corroborative evidence. The FRC has clarified through its Annual Audit Quality Inspection Reports that auditors should set precise expectations, use disaggregated data where possible, and define acceptable thresholds before comparing actual results. For going concern assessments under ISA (UK) 570, the FRC expects auditors to evaluate financial ratios indicative of solvency distress, including current ratio deterioration, interest coverage declines, and negative working capital trends, alongside cash flow forecasting and covenant compliance analysis.

Practical Guidance for United Kingdom

UK practitioners should leverage data from Companies House filings, FAME database, and sector-specific publications from bodies such as the Office for National Statistics and the Bank of England when establishing ratio benchmarks. For private companies, the ICAEW's Financial Reporting Faculty provides guidance on common ratios and their interpretation in the context of UK GAAP and IFRS reporters. When performing ratio analysis for planning purposes, auditors should compute current ratio, quick ratio, debt-to-equity, interest coverage, gross margin, net margin, inventory turnover, receivables days, payables days, and return on capital employed, comparing each against prior periods, budgets, and industry norms. The precision of the expectation should be commensurate with the materiality of the balance and the reliability of the data used to form the expectation.

Audit Expectations

The FRC Audit Quality Review team has identified several recurring deficiencies in how UK firms apply analytical procedures. These include failure to develop sufficiently precise expectations before comparing to actual results, use of overly broad thresholds that fail to identify material misstatements, inadequate investigation of identified variances where auditors accept management explanations without corroboration, and insufficient documentation of the auditor's rationale for concluding that analytical procedures provide sufficient appropriate audit evidence. The FRC expects that where ratio analysis is used as a substantive procedure, the auditor must document the expectation, the threshold for investigation, the actual result, any variance analysis performed, and the conclusion reached. Audit working papers should demonstrate genuine intellectual engagement rather than rote calculation.

United Kingdom-Specific Considerations

The United Kingdom's insolvency framework under the Insolvency Act 1986 and the Companies Act 2006 establishes specific tests relevant to going concern ratio analysis. The cash flow test asks whether the company can pay its debts as they fall due, while the balance sheet test considers whether liabilities exceed assets. Auditors should evaluate financial ratios in light of these statutory tests, particularly the current ratio, quick ratio, and cash conversion cycle. The wrongful trading provisions under Section 214 of the Insolvency Act create director liability where directors knew or ought to have concluded there was no reasonable prospect of avoiding insolvent liquidation. This legal framework underpins the importance of ratio analysis in going concern assessments. Additionally, the UK Corporate Governance Code requires boards of premium-listed companies to assess prospects over a longer period, creating demand for forward-looking ratio projections that extend beyond the standard twelve-month going concern assessment window.

Common Inspection Findings

Auditors failed to set precise quantitative expectations before comparing actual ratios to benchmarks, treating analytical procedures as a confirmatory rather than investigative exercise.

Thresholds for investigating ratio variances were set too broadly, meaning material fluctuations went uninvestigated in the audit working papers.

Management explanations for significant ratio movements were accepted without corroborative evidence, particularly for gross margin changes and receivables days increases.

Insufficient disaggregation of data meant that offsetting variances in different business segments were not identified through entity-level ratio analysis.

Going concern ratio analysis was performed mechanically without connecting deteriorating financial ratios to the specific insolvency tests under the Insolvency Act 1986.

Documentation of the auditor's independent expectation was absent, with working papers suggesting the expectation was reverse-engineered from the actual results.