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Industry Norms and Ratio Analysis
Customers' financial ratios are often compared to industry norms. The question credit managers need to ask is this: Are industry norms representative of the results of the industry as a whole? A careful analysis of how industry norms are compiled reveals the following weaknesses:
- Much of the financial information used to generate industry norms comes from public companies. However, the overwhelming mamjority of customers (of companies in the United States) are not publicly traded.
- Certainly some of the financial information used to generate industry norms comes from privately held companies. The question is what type of privately held company would share financial information with outside entities. The answer is that profitable privately held companies are more likely to share financial statements with credit reporting agencies than unprofitable companies.
Therefore, I would argue that the industry norms that some trade creditors use as a benchmark against which their own customers' financial performance may not be representative of the industry in which their customers operate. The information presented as industry norms are skewed by public company financial information as well as a non-representative sample of privately held companies.
With this in mind, industry norms, no matter what the source, must be viewed with some degree of professional concern or skepticism. To do otherwise would be unfair to customers and applicants.
© 2009 by Michael C. Dennis. All Rights Reserved. Michael is the author "Credit and Collection Handbook."