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  The Need for Comparison

Introduction to The Need for Comparison

Just calculating a ratio will not tell us deeply about the position or performance of a business. For instance, if a ratio revealed that a retail business was producing £100 in sales revenue each square metre of floor space, it would not be feasible to presume from this information alone whether this specific level of performance was good, bad or indifferent. It is only while we evaluate this ratio with some 'benchmark' that the information can be evaluated and interpreted.

Past periods

Through comparing the ratio we have calculated with similar ratio, but for a preceding period, it is feasible to detect whether there has been an enhancement or deterioration in performance. Certainly, it is frequently helpful to track specific ratios over time (say, five or ten years) to see whether it is feasible to detect trends. The comparison of ratios from dissimilar periods brings specific problems, though. Particularly, there is all the time the probability that trading conditions were quite dissimilar in the periods being compared.

There is the additional problem that, while comparing the performance of a single business over time, operating inefficiencies might not be clearly exposed. For instance, the fact that sales revenue each employee has increased by 10 % over the previous period might at first sight come out to be satisfactory. Though, this might not be the case if identical businesses have displayed an enhancement of 50% for similar period or had much better sales revenue per employee ratios to start with. At last, there is the difficulty that inflation may have distorted the figures on which the ratios are based.

Similar businesses

A business must refer its performance in relation to that of another businesses operating in similar industry, in a competitive environment. Survival may rely on its ability to attain comparable levels of performance. A helpful basis for comparing a specific ratio, so, is the ratio attained by similar businesses during the same period. This basis is not, however, without its problems. Competitors may have dissimilar year ends and so trading conditions may not be similar. They may also have dissimilar accounting policies that can have an important influence on reported profits and asset values (for instance, several methods of calculating depreciation or valuing inventories). At last, it may be hard to acquire the financial statements of competitor businesses. For instance, Sole proprietorships and partnerships are not obliged to create their financial statements that available to the public. In the issue of limited companies, there is a legal obligation to do so. Though, a diversified business might not give a breakdown of activities that is adequately detailed to enable analysts to compare the activities along with those of other businesses.

Planned performance

Ratios might be compared with the targets which management developed before the start of the period within review. The comparison of planned performance with actual performance might therefore be a helpful way of revealing the level of achievement achieved.

Though, the planned levels of performance must be relies on realistic assumptions if they are to be helpful for comparison reasons. Planned performance is probable to be the most important benchmark against which managers might assess their own business. Businesses that are be apt to develop planned ratios for each aspect of their activities. While formulating its plans, a business might helpfully take account of its own past performance and the performance of other businesses. Though, there is no reason why a specific business should seek to attain either its own preceding performance or that of other businesses. Neither of these might be seen as a suitable target.

Analysts outside the business do not generally have access to the plans of businesses. For these people, past performance and the performances of other identical businesses may give the only practical benchmarks.

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