Question

What are some limitations of comparing a firm’s ratios to industry numbers?

Answer 1

Ratio analysis is one of the most powerful tools for analysing companies. Most ratios are compared with benchmark companies which are the ones which are accurate and used for comparison in industry ratios. The major limitation of comparing of firms ratios to the industry numbers is that the benchmark companies may not be suitable. Different divisions of the same company may require different benchmark companies and hence comparing ratios to industry numbers may be totally misleading.

Companies that are used for comparison maybe dealing in different products or they may have different accounting practices and hence comparisons may not be valid. Also the scale of the company may differ from those used in industry analysis. The benchmark companies may be window dressing their accounts which renders the results useless.