Syllabus A. Role Of The Senior Financial Adviser A2. Financial strategy formulation

A2a. Ratio limitations 2 / 9

Syllabus A2a)

Assess organisational performance using methods such as ratios and trends

Ratios aren't always comparable

Factors affecting comaparability

  1. Different accounting policies

    Eg One company may revalue its property; this will increase its capital employed and (probably) lower its ROCE

    Others may carry their property at historical cost

  2. Different accounting dates

    Eg One company has a year ended 30 June, whereas another has 30 September

    If the sector is exposed to seasonal trading, this could have a significant impact on many ratios.

  3. Different ratio definitions

    Eg This may be a particular problem with ratios like ROCE as there is no universally accepted definition

  4. Comparing to averages

    Sector averages are just that: averages

    Many of the companies included in the sector may not be a good match to the type of business being compared

    Some companies go for high mark-ups, but usually lower inventory turnover, whereas others go for selling more with lower margins

  5. Possible deliberate manipulation (creative accounting)

  6. Different managerial policies 

    e.g. different companies offer customers different payment terms

Compare ratios with

  1. Industry averages

  2. Other businesses in the same business

  3. With prior year information