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:

• Some of the financial information used to generate industry norms comes from public companies, but for most creditors the majority of their customers are not publicly traded companies.
  
• Clearly, some of the financial data used to generate industry norms comes from privately held companies. but the key question is what kinds of privately held companies share financial information with outside entities. Generally speaking, the more prosperous a privately held companies is the more likely the company is to share financial statements.
  

What does this mean? This may mean that the industry "norms" that creditors use as a benchmark against which their customers financial performance is measured may not in fact not be the norm. If this is true, then these "head to head" comparisons may paint an unrealistically unfavorable picture of a customer's financial performance.

With this in mind, industry norms - no matter what the source - must be viewed with some degree of skepticism. To do otherwise would be unfair to customers and applicants.

Source: "Credit and Collection Manager's Manual" edited by Michael Dennis and Steven Kozack.