Why is it sometimes misleading to compare a company’s financial ratios with those of other firms that operate in the same industry?

Why is it sometimes misleading to compare a company’s financial ratios with those of other firms that operate in the same industry?

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December 18, 2021
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Why is it sometimes misleading to compare a company’s financial ratios with those of other firms that operate in the same industry?

Answer and ExplanationSolution by a verified expert

Here is a tip:
Firms that operate in the same industry may still possess many internal differences, including in their accounting practices.

Explanation
It can be erroneous to compare firms within the same industry, because they may have different accounting methods as well as different services and products. They may also have different subsidiaries and investments in their portfolio.

Comparing Dell and Apple will be misleading because apart from their computer hardware businesses, Apple also owns many other businesses, and employs thousands of other hardware and software products, while Dell sell almost exclusively computers.

Verified Answer
It can be misleading to compare financial ratios of firms in the same industry due to their accounting methods.

Firms in the same industry space may also have variegated products and technologies.

Tip: When comparing firms in the same industry, be cautious as they may have diverse internal practices, including accounting methods, which can skew financial ratio comparisons.

Explanation: It's important to exercise caution when comparing financial ratios of companies within the same industry. Despite operating in similar sectors, these companies may employ different accounting methods, leading to potential inaccuracies in the comparison. Additionally, variations in the range of products and technologies offered by these firms can further complicate a straightforward analysis. For instance, comparing Dell and Apple might yield misleading results, as Apple's business extends beyond computer hardware, encompassing diverse products and services, while Dell primarily focuses on computer sales. This disparity in business scope and offerings can significantly impact the validity of financial ratio assessments.

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