- Determine why it is sometimes misleading to compare a company’s financial ratios with those of other firms that operate within the same industry. Support your response with an example from your research.
Comparing financial ratios of companies within the same industry may be misleading because some companies may have investments in other industries that could distort the comparison. An example of this would be comparing Facebook and Twitter’s financial ratios.
Different companies use different accounting techniques when preparing their financial statements. Companies use different accounting methods when computing their financial ratios. One company may be using First in First out method (FIFO) to value its inventory while another company may be using Last in First out method (LIFO) (Persons, 2011). The company using FIFO method will have a higher value of inventory compared to the company that uses LIFO method.Therefore when financial ratios are compared, their results will differ thus misleading information.Inflation also affects the financial ratio analysis. Inflation may affect one country and not another country (Barton, & Court, 2012). Those firms located in a country facing inflation will have different financial ratios compared to those not affected. Inflation affects a company’s balance sheet. Therefore comparing these ratios will be misleading because one firm is affected by inflation and another one is not