What Is Industry Ratio Analysis?

Jim B.
Jim B.
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An industry ratio analysis is a method of studying companies by assessing the financial details of the industry that they inhabit. This is accomplished through the use of financial ratios, which are mathematical measurements designed to assess key business aspects like profitability, efficiency, and debt management. Conducting a proper industry ratio analysis requires compiling all of the different financial ratios for all pertinent businesses in an industry and then calculating average ratios for the entire industry. It allows analysts to study the industry as a whole or compare the ratios of one business to the averages of the entire industry.

Financial analysis generally requires that some attention be paid to the numerical information gathered from a company's income reports and balance sheets. The problem with this information is that it can actually be misleading without some sort of context to ground it. For example, comparing the profitability ratio of a company in the retail industry to a similar ratio of a car dealership is meaningless. Different industries have different financial circumstances surrounding them. An industry ratio analysis is effective in arranging all of this information into a concise and useful manner.

To compile an industry ratio analysis, it is first necessary to understand how financial ratios work. Ratios take two pieces of financial information, such as, for example, a company's assets and its revenue, divide one into the other, and emerge with a number depicting the performance of one aspect of a business. Among the many areas that ratios help illuminate are profitability, liquidity, efficiency, future growth potential, and reliance on debt.

These ratios must be compiled for each company that comprises an industry. At that point, an industry ratio analysis requires taking the average of each specific ratio. In this way, the industry can be measured as a whole. Since these raw numbers have little meaning without some means of comparison, ratios for the years immediately preceding the present year are considered. The ratios can then give a picture of positive or negative trends within the industry.

Performing an industry ratio analysis allows the managers of a single company within the industry to amass a set of statistics that are germane to their own business. The managers can use these industry ratios as benchmarks. By comparing where their own ratios are compared with the benchmarks, managers have a way of knowing if their own business is keeping up with its competitors. If some of the ratios are lacking, they also know what areas of the business need to be addressed.

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