Monday, 17 May 2010

Comparative Industry and Company Financial Ratios

Just looking at a single ratio does not really tell you much about a company.  You also need a standard of comparison, a benchmark.   There are three principal benchmarks used in ratio analysis.

Financial ratios can be compared to the:

  1. ratios of the company in prior years, 
  2. ratios of another company, and
  3. 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:
  Comparative Industry and Company Financial Ratios

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?

No comments: