Ratios, by themselves, are unreliable as sole basis for decision-making.They need to be ‘read' in a series of at least two or three ratios, to gauge a Company's financial position Further, they need to be ‘benchmarked', to decide whether the ratio is a healthy one or not.

 

A benchmark is a basis for comparison

Benchmarks are of three types:

•The Company's history, trends.

•Comparison of the Company with specific industry competitors.

•Industry wide comparison.

 

Common Size Statements

Apart from benchmarking, common size statements are another way of rationalizing readings from ratio analysis.

 

It basically involves comparing factors (with either a competitor or industry average). Cash e.g. should be seen as a:

•Fraction of Equity, for both Companies, (or Industry average) before comparing.

•Variable input, depending on terms of business. XYZ Co. may be more cash oriented, ABC Co. may be more credit oriented.

•Calculate ratio of cash to Total Assets    

• Calculate ratio of cash to Total Equities.