Accounting – 6.3 Inter-firm comparison | e-Consult

When comparing the financial statements of different companies, several problems can arise due to variations in accounting practices and business circumstances. Here are three key problems:

• Different Accounting Policies: Companies may use different accounting policies, even when reporting the same type of transaction. This can significantly affect the reported figures.

  Example: One company might use the FIFO (First-In, First-Out) method for valuing inventory, while another uses the weighted average method. This difference will lead to different cost of goods sold and ultimately different profit figures.

• Different Industries: Companies operate in different industries, which inherently have different financial characteristics. Comparing a high-growth technology company with a mature utility company is difficult.

  Example: A technology company might have high revenue growth but low profit margins, while a utility company might have stable, low profit margins. Direct comparison of profit figures would be misleading.

• Different Size and Scale: The size and scale of a company can influence its financial ratios. Larger companies may have different capital structures and operating efficiencies than smaller companies.

  Example: A large company might have a higher debt-to-equity ratio due to its larger borrowing needs for expansion, while a smaller company might have a lower ratio because it relies more on owner's equity. Comparing these ratios directly without considering the company size is problematic.