Accounting – 6.3 Inter-firm comparison | e-Consult
6.3 Inter-firm comparison (1 questions)
It is not appropriate to simply compare the PBIT figures of Alpha Ltd and Beta Co. to determine profitability because PBIT is influenced by the company's asset base. A higher PBIT doesn't necessarily mean higher profitability if the company has significantly more assets. A company with more assets might have a lower profit margin.
To make a more informed comparison, the student should consider other financial ratios that account for the size of the company. Two suitable ratios are:
- Profit Margin: This ratio measures the percentage of revenue that remains as profit after all expenses are deducted.
Calculation: (PBIT / Revenue) x 100. Comparing profit margins allows for a more accurate assessment of how efficiently each company generates profit from its sales, regardless of its asset size.
- Return on Assets (ROA): This ratio measures how effectively a company uses its assets to generate profit.
Calculation: (PBIT / Total Assets) x 100. ROA indicates how much profit a company generates for every pound invested in its assets. A higher ROA suggests better asset utilization and therefore greater profitability.