Relative Financial Ratios

Single ratio is meaningful only relative to:

• industry norms (most common, if wide variations within industry, use median instead of mean, better not to use all the firms but use cross-sectional analysis-subset of firms with similar size and characteristics),
• overall economy norms( important when overall business condition are changing, the company’s own historical performance (very common, often conduct time-series analysis , consider trends in ratio)
• The company's past performance – This is a very common analysis. It is similar to a time-series analysis, which looks mostly for trends in ratios.

Goodness of ratios: some desirable to close the industry norms; some the higher, the better eg return on asset, profit margin; some depends on the context eg high ROE resulted from high profit margins or asset turnover is good but resulted from high leverage met with a great deal of skepticism