How to compare financial ratios to industry average

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Financial ratios express relationships between two or more financial statement items. They are useful for comparing a company's financial performance against its historical performance and against industry averages.

Ratios indicate a company's ability to pay its short-term bills and long-term debt obligations, its profitability and its stock market value relative to its peers. Compare a company's financial ratios to industry averages using free or subscription-based online tools.

Familiarise yourself with the financial ratios. For example, the current ratio equals current assets divided by current liabilities. It measures a company's ability to pay its short-term bills and debt obligations. Another useful ratio is the return-on-equity ratio, or ROE, which equals net income divided by shareholders' equity. ROE measures how well management has utilised the invested capital. Comparing your company's ratios to the industry averages will show how well you are doing against your industry peers.

Open the Yahoo! Finance Industry Center Web page. The top industries will be listed on the left hand side; click "Complete Industry List" to display a more comprehensive list. Click on an industry to open a new Web page showing various industry news and data. On the right hand side of the page, you will find the "Industry Statistics" section listing key industry averages, including ROE. Click "View Industry Browser" just below this section to compare the ratios of several publicly listed companies in this industry. (See Resource #2)

Open the MSN Money "Company Key Financial Ratios" Web page. Select a publicly listed company that most closely resembles your business. For example, if you are in general merchandise retail, Wal-Mart (ticker symbol "WMT") could serve as a proxy. Enter the stock symbol in the "Find Financial Results For" field in the upper right hand side, just below the market data, and click "Go" to display the financial ratio comparisons.

MSN Money displays the financial ratios for the selected company, its industry and the S&P 500 (a broad market index of large-cap U.S. companies). The financial ratios are grouped in several categories, such as sales and profit growth rates; financial condition ratios, including current ratio and debt-to-equity ratio; and investment return ratios, such as ROE.

Compare your company's financial ratios against the industry averages. There is no need to panic if the ratios do not match up exactly with other companies or with the industry averages, but dig a little deeper if there are wide variations. For example, if the industry average net profit margin is 10 per cent while your company is at 3 per cent, then there could be room for improvement in your cost structure. You should also compare the ratios against your company's historical performance to get a more complete picture of the trends. Look for consistency or steady improvement in the ratios over time.