Financial ratios can be compared to the:
- ratios of the company in prior years,
- ratios of another company, and
- industry average ratios.
1. Historical comparison.
The first useful benchmark is history.
- How has the ratio changed over time?
- Are things getting better or worse for the company?
- Is gross margin going down, indicating that costs are rising faster than prices can be increased?
- Are receivable days lengthening, indicating there are payment problems?
2. Competitor comparison.
The second useful ratio benchmark is comparing a specific company ratio with that of a competitor.
- For example, if a company has a significantly higher return on assets than a competitor, it strongly suggests that the company manages its resources better.
3. Industry comparison.
The third type of benchmark is an industry-wide comparison.
- Industry-wide average ratios are published and can give an analyst a good starting point in assessing a particular company's financial performance. Click here for a chart showing various ratios for a variety of companies in different industries:
Note that there can be large differences in ratio values between industries and companies.
Review the chart. What do the ratios tell us about companies and industries?