Comparing business reports to other measures
So far we’ve examined comparing the business to itself through the prior period. But what other comparisons to users of financial statements make to help them in their decision making?
It is difficult to conduct horizontal or vertical analysis using industry averages because no one creates an industry average set of financial statements. However, many analysis websites collate firms in the same industry to create industry averages for ratios. Therefore, you can compare the current ratio of one business, to the industry average to determine how the business is performing against the rest of the industry.
There are some caveats to this approach. For example, some industries may have very large and very small players. A small owner-operated IGA Supermarket would have a slightly different business model and buying power than Woolworths or Coles and thus comparing the IGA supermarket ratios to a major supermarket chain might not be useful.
Another caveat is where an industry grouping might be very diverse. For example, biotechnology could include a whole range of firms, from medical research to large pharmaceutical companies – the businesses in the industry average might not be similar (or homogenous), resulting in averages that might not be meaningful.
Trends over time
We have examined just two years in our analysis, however, the more data points that you have, the greater the chances of seeing a trend develop over time. Analysis websites like Morningstar and Investing.com will show longer trends of data.
The final comparison a business may make is between their ACTUAL performance (based on recorded transactions) and their BUDGET or FORECAST for the same period. Did they do better than their budget? Generate more revenue? Decrease expenses?
We will learn in a later section that budgets can be manipulated, especially when part of a performance measurement or bonus scheme, perhaps artificially. Therefore any comparison to budgets should be made with a healthy dose of scepticism.