Question

Your boss, the CEO, asks you to analyze our company's performance in relation to our competitors, but she only gives you a short timeframe for the project. You can do this either by comparing the firms' balance sheets and income statements or by comparing the firms' ratios. If you only had time to use one means of comparison, which method would you use and why? What are the drawbacks of using your selected method?

It is commonly recommended that the managers of a firm compare the performance of their firm to that of its peers. Increasingly, this is becoming a more difficult task. Explain some of the reasons why comparisons of this type can frequently be either difficult to perform or produce misleading results.

Answer 1

I will be using financial ratio in order to compare the performance of my company in respect to other companies in the industry because financial ratios are are properly reflecting the quantitative analysis of the company in order to help the analyst to perform the analysis regarding the company in respect to the peers and it will be helping to find out whether the company is underperforming or the company is outperforming its competitors in the same industry.

I will be trying to use the financial ratio analysis as it will be helping me with order to find out the liquidity and the solvency along with Asset Management ability of the company in the long run so I would be trying to find out the performance of the company on different front with that of its competitors.

Drawbacks of this method would be that there would be no qualitative analysis of the financial statement and these are mere data which can lead to delusional analysis as no books of accounts are 100% accurate

Reasons why comparison to company with the competitors lead to misleading results would be-

A. different type of accounting assumptions followed in their preparation of books of accounts

B. Different type of risk aversion and risk loving strategies

C. Difference in their capital budgeting approach and capital structure

D. Business reputation of companies.