Financial ratios are helpful economic benchmarks which can assist in quick evaluation of particular industries and their general condition. However, the industry financial ratios have no universal measures on their own, so different industries can have significantly varying ratios depending on their specifics. To prove that point, I will compare construction and retail industries from the perspective of several financial ratios, including solvency, liquidity, and profitability.
Solvency Ratio: Interest Coverage
The interest coverage ratio reflects the company’s ability to pay its debts. In 2020, the US retail industry showed a 2.18 ratio, suffering more than a 100% decrease than 2019 (Retail trade, n.d.). The construction industry had a much higher ratio of 9.36 (Construction, n.d.). In my opinion, retail severely suffered from the COVID-19 pandemic since it relies on logistics and supply chains much more than construction, which often can be done locally. Overall, retail is a more fluctuating industry, while construction has greater stability, explaining the difference in interest coverage ratios.
Liquidity Ratio: Quick Ratio
The quick ratio measures a company’s ability to extinguish current liabilities such as bonds and loans. In 2020, the retail industry had a 0.60 quick ratio (Retail trade, n.d.). In comparison, the construction industry showed a 1.01 ratio (Construction, n.d.). That means the retail companies have fewer quick assets available for use if the need arises. This difference is understandable since the construction industry usually deploys expensive equipment and technology, which can be sold in emergencies. Therefore, retail companies face higher risks when it comes to dealing with the current liabilities.
Profitability Ratio: Gross Margin
Gross margin is a ratio between gross profit and sales revenue. As I can see, a bigger percentage of gross margin means a shorter supply chain or lower production costs. The retail industry finished 2020 year with a 31,3% gross margin (Retail trade, n.d.) Compared to that, the more stable construction industry managed to get only an 18,2% result (Construction, n.d.). I would expect that companies working in areas like IT can achieve an even higher gross margin since they are not demanding in terms of supplies or equipment.
Uses and Limitations of Financial Ratios
Like any instrument, financial ratios have their uses and limitations. Most importantly, they can serve as a measurement of overall financial health. For example, solvency ratios can help evaluate a company’s ability to honor obligations, which could be crucial for banks’ or investors’ decision-making. Secondly, the ratios are well-suited for tracking year-by-year dynamics and troubleshooting the company’s problems before it becomes too late. However, financial ratios have several limitations, such as the difficulty of cross-national analysis due to differences in national tax laws or extraordinary events that can distort the real picture. Therefore, I find financial ratios more useful on the national level, when the companies or even whole industries play in more or less even legal field.
References
Construction: Average industry financial ratios for U.S. listed companies (n.d.). Ready Ratios. Web.
Retail trade: Average industry financial ratios for U.S. listed companies (n.d.). Ready Ratios. Web.