Question

Ratio analysis is more complicated when a company is a conglomerate…a group of commonly owned businesses or companies but often with multiple types of products; services; businesses. Why is ratio analysis thus more complex?

Answer 1

Ratio analysis is a financial analytical tool used for analysis and interpretation of financial statement numbers. It helps in understanding the financial statements in a better way for the end users to take decision on the financial statement related matters. Ratio analysis involves a lot of calculations like computation of current assets, current liabilities, capital employed, shareholders’ equity. Etc. For example Current ratio is calculated based on current assets and current liabilities. It indicates the liquidity of the firm with which it can repay its short term obligations.

When a firm has multiple types of products, services and businesses it becomes difficult to identify the components needed for ratio calculation. For example a firm should have separate record of assets deployed in the business and the total capital employed for a business for computation of ratios. A firm should do ratio analysis for each division so that ratios are meaningful for each division for comparison with other divisions and other firms. Thus ratio analysis for a conglomerate having multiple products, services and businesses is more complicated compared to a firm not engaged in many business types. For ratio analysis to be meaningful there should be consistency in applying the concepts and calculation of each ratio.