Compare businesses using ratios with care
Use inter-business ratios to identify differences while testing whether the businesses, periods and accounting policies are comparable.
Section 6.3 · Inter-business comparison
Cambridge IGCSE Accounting 0452 / (9–1) 0985, 2027–2029 Version 1. These lessons follow the 2027–2029 syllabus only; the separate 2026 syllabus update is not yet mapped. Written practice is self-checked, not an official Cambridge grade. Full timed-paper practice and human subject-teacher review remain pending.
Before you begin
- No previous accounting study is assumed. Keep the business, transaction and accounting period in view, and distinguish a resource, a claim and a performance result.
Work on paper. Try each question before revealing help, and explain why your method works.
Quick readiness check
Two businesses use different depreciation methods. What should an analyst do before comparing profit ratios?
What you will learn
- Identify factors affecting two businesses' ratios
- Explain problems of inter-business comparison
- Make a qualified comparison using evidence
Check comparability first
Ratios may differ because of business size, industry, product mix, location, pricing, seasonality, credit policy or economic conditions. Similar ratios do not prove that operations are identical.
Accounting policies, inventory valuation, depreciation methods, year-end dates and estimates may also differ. Check that the periods and formulae use consistent bases before comparing results.
State what the evidence supports
Use more than one ratio and relevant statement information. Describe the observed difference, give a plausible explanation supported by the data and identify information still needed.
Do not declare a business better solely because one ratio is higher. A high inventory turnover, for example, may indicate efficiency or insufficient stock, depending on demand and service requirements.
Pause and explain
A retailer has a higher current ratio than a manufacturer. Is it automatically more liquid?
Worked example
Business A has inventory turnover 8 times and Business B 5 times. Both sell different products and have different year ends. State what can be concluded and what should be checked.
Show the worked solution
- A's inventory turnover is higher on the reported data.
- Different products, demand patterns and year ends may affect the comparison.
- Check comparable periods, stock policy, shortages and sales patterns before deciding which business manages inventory better.
Answer A reports faster inventory turnover, but product and period differences limit the comparison. Check demand, stock-outs, policies and comparable dates before evaluating performance.
Try a topic test
Choose Easy, Normal or Difficult. Save your answers and open worked review after finishing.
Test this topic →From guided practice to a new situation
Write your answer and reasoning first. Use a hint only if you are stuck. The model solution is for self-checking; your written work is not automatically marked.
Two firms report gross-profit margins of 28% and 34%. Identify three factors to check before concluding that the second firm performs better.
Give me a hint
Consider products, prices/costs and reporting choices.
Compare my reasoning
- Check product mix, selling prices, supplier prices and sales quantities.
- Compare inventory valuation policies and periods.
- Consider service quality and market conditions before ranking the firms.
Check product mix, pricing and purchasing costs, inventory policies, period dates and non-financial context before concluding the second firm performs better.
Look for these in your work
- At least three factors
- Accounting basis checked
- Conclusion qualified
A firm reports payables days of 80 while its competitor reports 45. State one possible benefit and two risks of the longer period, and what data would help.
Give me a hint
Compare the period with supplier terms and service continuity.
Compare my reasoning
- A longer period may preserve cash for longer.
- It may exceed agreed terms, cause lost discounts or strain supplier relationships.
- Check credit terms, discounts, overdue balances and supply interruptions.
The longer period may help short-term cash, but can breach terms, lose discounts or damage supply. Compare the actual terms and payment record.
Look for these in your work
- Possible benefit stated
- Two risks stated
- Evidence needed identified
A seasonal business reports a stronger current ratio at its year end than a non-seasonal competitor. Explain one comparability problem and one additional comparison to make.
Give me a hint
Consider when inventory and receivable balances are measured.
Compare my reasoning
- A seasonal year-end may follow a peak in cash or a low-stock period unlike the competitor's cycle.
- Compare ratios at comparable dates or review monthly balances across the year.
- Also examine cash, inventory and receivables composition.
The different seasonality and reporting date can distort the comparison. Review comparable periods and the composition of current assets and liabilities.
Look for these in your work
- Seasonal timing explained
- Additional comparison relevant
- Balance composition checked
Common mistakes
- Assuming the same ratio means the same performance
- Ignoring policy and year-end differences
- Treating a higher turnover as always better
- Making causal claims without operational evidence
What can you explain now?
Why can different year ends make a ratio comparison less reliable?
Compare with the explanation
The periods may capture different seasonal conditions
The timing can change balances and activity included in the comparison.
After trying it yourself, choose your next review. This is your self-assessment.
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Make it stick
Name one operational and one accounting-policy factor that can affect a ratio comparison.
If you needed the solution, close it and solve the problem again from a blank page. A correct answer is stronger when you can explain the reason for each step.