Inter-Firm Comparison (Copy)
What is Inter-Firm Comparison?
- Inter-firm comparison means comparing accounting ratios and performance indicators of one business with another.
- Helps identify strengths, weaknesses, and competitiveness in the market.
- Commonly used by:
- Business owners
- Investors
- Creditors
- Industry analysts
Problems of Inter-Firm Comparison
- Different accounting policies
- One firm may use straight-line depreciation, another reducing balance.
- Inventory may be valued using cost or net realizable value — affects profit margins.
- Different financial year ends
- One company may end accounts in June, another in December — seasonal sales variations may distort results.
- Differences in size and scale
- A large firm may have lower costs per unit than a small firm due to economies of scale.
- Industry type and product differences
- Different industries have different average margins (e.g. retail vs. manufacturing).
- Even in the same industry, product pricing and quality may vary.
- Location/geographical differences
- Labour, rent, or tax costs can differ across cities or countries, affecting profitability and liquidity.
- Access to finance or credit terms
- One firm may get longer credit from suppliers, affecting its trade payables days positively.
Accounting Ratios Used in Inter-Firm Comparison
| Ratio | Used to Compare… | Example Comparison |
|---|---|---|
| Gross Margin | Pricing and cost control | Firm A = 45%, Firm B = 30% → A is more efficient in COGS management |
| Profit Margin | Expense control | Firm A = 18%, Firm B = 12% → A controls expenses better |
| ROCE | Return on investment | Firm A = 20%, Firm B = 15% → A uses capital more effectively |
| Current Ratio | Liquidity | Firm A = 1.8:1, Firm B = 1.2:1 → A has better short-term solvency |
| Liquid Ratio | True liquidity (excluding stock) | Firm A = 1.3:1, Firm B = 0.9:1 → A is more liquid |
| Inventory Turnover | Inventory management | Firm A = 10 times, Firm B = 5 times → A turns over stock faster |
| Trade Receivables Days | Credit control on customers | Firm A = 30 days, Firm B = 60 days → A collects cash faster |
| Trade Payables Days | Credit terms from suppliers | Firm A = 35 days, Firm B = 20 days → A has better supplier terms |
Example: Inter-Firm Comparison Interpretation
| Ratio | Firm A | Firm B | Interpretation |
|---|---|---|---|
| Gross Margin | 50% | 35% | A has better cost control |
| Net Profit Margin | 20% | 10% | A manages expenses more efficiently |
| Inventory Turnover | 6 times/year | 3 times/year | A has better stock movement |
| Trade Receivables Days | 25 days | 45 days | A collects receivables more quickly |
| ROCE | 22% | 14% | A makes more profit for every dollar invested |