You are advised to approach the job with caution and always keep in mind four key questions:
- Am I comparing like with like?
- Is there an explanation?
- What am I comparing it with?
- Do I believe the figures?
- Consider a company that writes off research and development costs as overheads as soon as they are incurred.
- Then suppose that it changes policy and decides to capitalize the research and development, holding it in the Balance Sheet as having a long-term value.
- A case can be made for either treatment but the change makes it difficult to compare ratios for different years.
- Greetings card manufacturers commonly deliver Christmas cards in August with an arrangement that payment is due on 1 January.
- The 30 June Balance Sheet may show that customers are taking an average of 55 days' credit.
- The 31 December Balance Sheet may show that customers are taking an average of 120 days' credit.
- This does not mean that the position has deteriorated dreadfully and the company is in trouble
- The change in the period of credit is an accepted feature of the trade and happens every year.
- It is of course important, particularly as extra working capital has to be found at the end of each year.
4. Do I believe the figures?