Question

1. How do you think financial ratios differ across different industries? Compare two industries of your choice and select a few ratios and explain whether you think the ratios would be higher or lower for each of those industries and explain why.

I choose trasport industries and education industries.

2. What are some uses and limitations of financial ratios?

Answer 1

1) (industry chosen: transport/logistics industry and education industry)

Financial ratios vary among industries depending upon the various requirements of the different industries. Some industry has too much capital investment like the Airline industry whereas in some industries the capital investment is negligible like the IT sector. It also depends upon the business pattern followed in the industry, for example in manufacturing industries there is high amount of working capital investment in terms of inventory and receivables whereas in the service industry there is no inventory at all like food delivery companies like Zomato.

Coming to transport and education industry: (the pair chosen here is not a good one, as both of them come under service industry, a pair containing a service-based industry and a manufacturing industry would be much better)

The education industry is one of a kind, it has negative working capital as the revenues (tuition fees) are collected pre-hand whereas the expense (salary to the tutor) occurs after the services have been provided. There is no concept of inventory in the education industry. Hence in the education industry, we can expect to see high turnover ratios (it will be affected by the way of operation, i.e. does the company own the buildings or has taken it on lease but still we expect to see high turnover ratios)

The logistics industry is a type of industry whose performance depends upon the well functioning of other industries.

Uses and limitation of financial ratios

Uses:

a) They are most commonly used for comparison with competitors and/or industry

b) They help identify the weak and strong areas of company operation (du pont analysis is based on this)

c) Ratios have the advantage of comparison between two companies which are very different from each other in size

d) They help in identifying trends over a period of time

e) Raios assists the top management in the decision-making process

Limitations:

a) Based on historical data, which may or may not accurately represent the future expectations

b) Ratios can be manipulated by companies by changing accounting policies, so it is very important to check what accounting policy company follows and its impact on the financial ratios

c) Seasonal effects can alter the ratio analysis process, proper steps must be taken to adjust the ratios for seasonal factors

d) Changes in accounting policy can alter the financial ratios drastically, company management can apt for a change in policy to show better than real performance