Need of Comparing Financial Performance

Written by True Tamplin, BSc, CEPF®

Updated on December 06, 2022

At the end of each financial year, every company produces the following accounts:

Essentially, these statements present—in a summarized form—all the information recorded in the company’s accounting books.

The results disclosed by these statements are of obvious importance to several stakeholders, including shareholders, directors, accountants, creditors, stock exchanges, and—of course—the government.

One of the prime uses of financial statements, from the point of view of almost all users, is to compare one company’s operational results and financial strength with those of others.

In fact, there is no better way to evaluate a company’s performance or position than to compare it with others. Pre-set targets or the previous year’s performance or norms may also be used. The comparison is usually made between the performance of:

  • The same unit over different periods
  • Different but related units
  • Different industries

An overview of each of these areas is given below.

Same Unit Over Different Periods

  • For example, comparing 2016's performance with 2015's performance
  • 2016's actual performance with 2016's forecast or budgeted performance

Different But Related Units

  • For example, comparing Department A's performance with Department B
  • Product A with Product B
  • Company A with Company B in the same business
  • New York branch with Washington branch
  • USA subsidiary with UK subsidiary
  • Company A with the average or normal performance of other companies in the same business

Different Industries

  • For example, comparing the performance of an oil marketing company with a tools retailing chain
  • Another example is the comparison of the performance of a manufacturing company with a financial services company

Figures contained in financial statements are absolute figures.

While these figures do serve the basic purpose of conveying the results achieved by the company in a given period, they are generally inadequate in themselves for the purpose of making a meaningful comparison.

Thus, the fact that Company A may make a net profit of $25 million and Company B of $40 million can lead to an impression that the latter company is more profitable.

However, with the information about Company A’s equity capital of $200 million and Company B’s $400 million, and expressing net profit as a percentage of equity capital, we can determine—more accurately—the efficiency of the company’s use of its funds.

The net profit percentage comes to 12.5% for Company A and 10% for Company B. The conclusion is now both clearer and more appropriate.

What a ratio essentially does is to provide a common base.

In the example above, the two figures of net profit are not comparable initially. However, when we take the two figures showing return on equity, we get one common factor: the equity in both cases is taken as 100.

The net profits of the two companies as a percentage of their respective equity figures thereby become comparable. This is the principal function of a ratio: namely, to provide a common base in two or more sets of figures so that they become comparable.

Need of Comparing Financial Performance FAQs

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide, a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, or check out his speaker profile on the CFA Institute website.