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

Answer 1

1. Every industry has specific requirements of capital, materials and different operation methods. The financial statements and balance sheets differ on these very differentials making the financial ratios different across sectors. If we consider the industry of food and computer manufacturers, food industry inventory turnover ratio is marginally higher as they need to account for spoilage whereas the computer manufacturing industry is not required to maintain a huge inventory but they need to be updated constantly with ever-changing technology and prices, resulting in much higher inventory turnover ratio when compared with the food industry. If we consider the quick ratio, which measures the company's ability to meet the short term obligations and an indicator of its short term liquidity position. This ratio varies hugely when we compare the general grocery stores and computer manufacturers, where the latter have a better quick ratio than a general grocery store.

2. Financial ratios give us a quick view of the fundamentals of the company without looking deep into the financial statements and balance sheets. We can easily compare the fundamentals of different companies even when they differ in sizes and we do not have high financial knowledge. There are certain limitations in using the financial ratios, as they primarily are based on the accounting figures which sometimes differ in appropriations and economic estimations. Also the figures in the statements are not inflation adjusted, resulting in distorted facts, the ratios hence may not give concrete conclusions of the industry.