Ratios Tell a Story—2011

Abstract

Financial results and conditions vary among companies for a number of reasons. The differences in industry characteristics, company policies, management performance, and responsiveness to the macroeconomic environment are reflected in the financial statements published by publicly held companies and can be highlighted through the use of financial ratios.

Excerpt

UVA-C-2332

Rev. Oct. 17, 2012

RATIOS TELL A STORY—2011

Financial results and conditions vary among companies for a number of reasons. One reason for the variation can be traced to the characteristics of the industries in which companies operate. For example, some industries require large investments in property, plant, and equipment (PP&E), while others require very little. In some industries, the competitive product-pricing structure permits companies to earn significant profits per sales dollar, while in other industries the product-pricing structure imposes a much lower profit margin. In most low-margin industries, however, companies often experience a relatively high rate of product throughput.

A second reason for some of the variation in financial results and conditions among companies is the result of management philosophy and policy. Some companies reduce their manufacturing capacity to match more closely their immediate sales prospects, while others carry excess capacity to be prepared for future sales growth. Also, some companies finance their assets with borrowed funds, while others avoid that leverage and choose instead to finance their assets with owners' equity. And some corporate management teams choose to not pay dividends to their owners, preferring to reinvest those funds in the company.

Of course, another reason for some of the variation in reported financial results among companies is the differing competencies of management. Given the same industry characteristics and the same management policies, different companies may report different financial results simply because their managements perform differently.

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Keywords: Financial results, macroeconomic conditions, financial conditions, financial ratios, financial metrics, DuPont ratio model, ROA