Question

Using sound financial theory, explain why you would expect to see differences in the financial ratios (e.g., debt ratios, current ratios, ROE, ROA) of firms in different industries.

Answer 1

Financial ratio is relative magnitiute of two selected numerical values taken from enterprise's financial statements. These ratios are used to evaluate the overall financial condition of a corporation or other organization. As different Industries face different risks, capital requirement and competion are usually hard to compare and we see difference in financial ratios of firms in different industries. Below are some reasons discussed in detail:

(a) Different industries have DIversified product lines, many business operate a large number of divisions in quite different Industries, in such cases we expect to see differences in financial ratios.

(b) Different industries have different seasons example one industry deals with products used in winters other in summers.

(c) Year End Adjustments: Some Industries make year end adjustments in financial statements due to which there is difference in financial ratios.

(d) Difference in accounting policies and accounting period: It can make the accounting data of two firms non comparable.