Inter-Firm Comparison: Introduction, Advantages and Limitations

After reading this article you will learn about Inter-Firm Comparison:- 1. Introduction to Inter-Firm Comparison 2. Purpose of Inter-Firm Comparison 3. Advantages 4. Limitations 5. Utility 6. Inter-Firm Comparison through Ratio Analysis 7. Centre.

Contents:

  1. Introduction to Inter-Firm Comparison
  2. Purpose of Inter-Firm Comparison
  3. Advantages of Inter-Firm Comparison
  4. Limitations of Inter-Firm Comparison
  5. Utility of an Inter-Firm Comparison Scheme
  6. Inter-Firm Comparison through Ratio Analysis
  7. Centre for Inter-firm Comparison Ltd



1. Introduction to Inter-Firm Comparison:

The method by which one firm is compared with other firms particularly when technol­ogy, product characteristics, production method and general operating conditions are same in the same industry, the same is known as inter-firm comparison. It would be more significant and meaningful if the performances of the firms are compared with that of the others, belonging to the same group, for a year or for a few years.

In that case, the position of the company can be judged in the industry. In other words, it is a technique by which one can evaluate the performances, efficiencies, profits and costs of a company with other companies in the industry.

But one thing should be remembered, i.e., comparison between the firms becomes meaningful when it is based on common definitions, usage, information relating to costs, profits, productivity and efficiencies as a whole.

Proper comparison is not possible between two unlike or different firms. So, needless to mention that in order to make an inter-firm comparison there must be a uniform costing system.

For this purpose, a central organisation/trade association or Chamber of Commerce is to be set up for collecting, analysing, interpreting and presenting the information (data) in a suitable form which will be used by its member firms in the industry.

Inter-firm comparison may be made not in the form of absolute figures but in the form of various ratios, usually the figures relate to cost accounting liquidity and profitability as well.

Thus, inter-firm comparison helps a company to know its own drawbacks by measuring its own performances with an efficient firm in the industry and can locate easily its week points which ultimately helps the firm to take the corrective measures for the future.

For this purpose, two cost accounting methods, viz, Standard Costing and Budgetary Control System can be applied for controlling cost and to increase the efficiency of the firm.

Thus, from the above discussion it becomes clear that the inter-firm comparison will be significant and meaningful provided:

(i) the firms must be under same age group (i.e., if comparison is made between a new firm and an old one, the same will not produce a clear picture);

(ii) they belong to almost same size (i.e., comparison between a small firm and a big firm (although they are producing the same articles) is of no use,

(iii) they must cater to the saipe market; and

(iv) they must be engaged with the same kind of business.

Proper comparison between two firms is possible only when the above conditions are satisfied. However, in real world situation, it is really difficult to get firms which follow the above conditions except, to some extent, cement and sugar industry. Even then, if the three conditions [(i), (ii) and (iv)] are satisfied, it will be meaningful after leaving an allowance for that purpose.

Moreover, the following procedure should carefully be followed for the purpose of inter- firm comparison between the firms :

(i) for the purpose of comparison, the data should be collected from a central body/ agency/or from the chamber of commerence or from trade association/agency;

(ii) for the purpose of analysing, scrutinising and presenting the data, proper secrecy must be maintained i.e.. instead of using absolute figures/information, percentage or ratios may be used;

(iii) in order to determine the efficiency and to compare the performances of other companies the management must be supplied with the necessary information; advanced financial analysis and planning

(iv) after realising the snags and weakness, an attempt must be made to show why the efficiency of the concerned firm is less than that of the other.



2. Purpose of Inter-Firm Comparison:

It has already been stated above that the purpose of inter-firm comparison is to compare the efficiency of one firm with that of other belonging to the same group of industry and helps the management to locate the problems or reasons for such inefficiency (if any) and to take the corrective measures for its improvement.

It has also mentioned in the earlier paragraph that there must be a central body/agency (like Chamber of Commerence) who will work i.e., will collect and analyze the information on behalf of the members by which many snags or drawbacks can be controlled However, some of the problems are enumerated below

(i) Is profit adequate ?

(ii) How efficient is production ?

(iii) How efficient is selling ?

(iv) Is Working Capital sufficient ?

(v) Is stock-turnover adequate ?

(i) Is Profit Adequate ?

The principal motivating force of all commercial firms is to earn profit i.e., whether the firm is successful or not, the same is measured by the amount of profit in relation to capital employed i.e., percentage of Return on Capital Employed (ROCE).

After careful compari­son, if it is found that the earning power of a firm does not at least equal that of the other similar firms there are some factors which are not operating efficiently. These may be isolated by means of certain ratios: viz.,

(a) supporting ratios;

(b) general explanatory ratios, and

(c) specific explanatory ratios

It should be remembered that while calculating capital employed, current replacement values of the assets should be taken into consideration and not the historical cost or nominal value.

(ii) How Efficient is Production ?

Usually the production departments have to produce an adequate volume of output at a reasonable cost so that profit will be maximized.

Thus, the costs of sales may be splitted up into:

(i) Direct material

(ii) Direct wages and

(iii) Production overhead in relation to sales value.

It is needless to say that comparison with the figures of other firms may locate a possible source of inefficiency e.g., machine or labour utilisation.

(iii) How Efficient is Selling ?

Question of profit does not arise if the goods which are produced by the firm are not sold The amount of total sales to operating profit and to capital employed are the primary ratios while considering profit earnings capacity which are known as supporting ratios.

The operating profit to sale ratio reveals the total profit earned by the amount of sales and the same may also be expressed in terms of percentage. The sales to capital employed, however, expresses how many times capital employed is covered by the amount of sales or it may be stated that how much is sold per rupee invested.

(iv) Is Working Capital Sufficient ?

This is a very significant aspect while making a comparison between the two firm. A firm having an inadequate working capital cannot be compared with a firm having adequate working capital. If there is insufficient working capital, production process cannot be carried on smoothly and miscellaneous problems will arise relating to liquidity, solvency and profitability of the firm.

(v) Is Stock-Turnover Adequate ?

If the Stock-Turnover ratio (i.e., cost of goods sold/sales to average stock) is very low, the firm will experience a problem of liquid funds.

Thus, the inter-firm comparison will become ineffective if one firm has a low Stock-Turnover ratio in comparison with the other firms having a high or normal Stock-Turnover ratio. This ratio is also very significant for the purpose of measuring liquidity, solvency and profitability position of a firm.



3. Advantages of Inter-Firm Comparison:

Proper inter-firm comparison presents the following notable advantages:

(i) There is no uncertainty in it as it is taken from a successful firm and as such, it helps the management to take corrective measures for its improvement in efficiency in near future.

(ii) Inter-firm comparison locates or points out the snags and weakness of the firm and thus assist the management to take all possible steps in order to improve the productivity of all factors which are directly connected.

(iii) It also helps the business world to run in the correct way.

(iv) This comparison helps the Government to regulate the prices of the commodity in the country.

(v) Since the data are collected and presented by the central agency/body, biasness is absent.

(vi) Inter-firm comparison develops the cost consciousness amongst its members since various ratios are known.

(vii) Inter-firm comparison presents not only the difference between the two firms, it also explains the reasons for such difference and suggest the possible remedies for its improvement both for liquidity and profitability aspect of the firms.



4. Limitations of Inter-Firm Comparison:

Inter-firm comparison is not even free from snags. Some of them are discussed here­under:

(i) It is very difficult to maintain the secrecy of the firm since the data are presented to its members.

(ii) It is not always possible to make a proper comparison between the two firms as identical position is hardly possible in the real world situation. Thus, it is not always effective.

(iii) In the absence of any. proper cost accounting system, the data so collected and presented cannot produce any reliable information for the purpose of making proper comparison. Thus, it will become fruitful only when both the firms maintain good costing system.

(iv) Sometimes the member firms do not prefer to disclose their data about the financial and operational performances.

However, some of the snags can be avoided by careful study, analysis and interpretation.

For example, secrecy can be maintained if ratios are use instead of absolute figures.



5. Utility of an Inter-Firm Comparison Scheme:

It has been highlighted above that a uniform costing system should be introduced and developed for a successful inter-firm comparison. Co-operation from all quarters,particularly the participating organisations, is needed. However, the following points should carefully be taken into consideration while its installation.

(i) Collection of Required Information and its Nature:

At its initial stage, its application was limited to the participating firms and the analysis was made on the basis of published annual accounts. At present, its application is not limited to the financial analysis of the firm. There is no hard and first rule about which should have been collected and presented before the member firms for their benefit.

How far the required information should be collected by the central body, depends upon the requirement of the management, comparative value of information and the efficiency of the central body/agency for collecting data. Mass data should not be collected since it may create confusion.

In other words, only the necessary data should be collected. In short, there is no such standard list of information which will equally be applicable to other firms.

However, collection of informa­tion in general are noted below:

(a) Analysis and interpretation of the following ratios; viz,

Return on capital employed;

Return on net worth;

Liquidity ratios (i.e., current ratio, liquid ratio etc.)

Creditors’ and Debtors’ velocity;

Stock Turnover ratio.

(b) Efficiency and Utilisation of labour;

(c) Efficiency and Utilisation of machinery;

(d) Production method;

(e) Information about cost structure and raw material consumed per unit etc.

(ii) Duty and Responsibility about Collection and Presentation of Information:

Although in our country, Inter-firm comparison is not effectively used but in developed country like U. K., the same is popularly accepted for the benefit of participating firms. In U. K. Centre for Inter-firm Comparison was established by the British Productivity Council in 1959.

The area of service covered by the centre includes consultancy service, research, conference on inter-firm comparison etc. for the benefit of the member units. Moreover, it supplies a fund for information for the non-member industries.

In our country, the respon­sibility for collecting and presenting the information has been given to: Chamber of Commerce and Industry, National Productivity Council, Research and Statistical Depart­ment of Government of India, Trade Associations, Manufacturing Associations., Trade Journals.

These journals contain necessary information either from the return submitted to various Government department or from published accounts,in the form of annual report. After careful analysis and observation from such journals a firm can compare itself with an efficient firm in the same line.

(iii) Procedure of Collection and Presentation of various Information:

Usually the member units supply the information to the central organisation periodically which is presented in standared form by the central organisation for making proper comparison. Sometimes, information may also be supplied, quarterly or half-yearly. But it is

easier to collect and present such information on yearly basis as the results are presented in the annual financial statement of the firms The information so collected are sorted out and a consolidated report is prepared and issued to the member units.

The information which is collected by the central organisation is kept confidential and ratios from such data are presented instead of absolute figures and it may also be presented with the help of code numbers.



6. Inter-Firm Comparison through Ratio Analysis:

It has already been highlighted above that ratio analysis is preferred for inter-firm comparison than absolute figures as the latter contains some snag in it For operational efficiency the ‘Pyramid uj Ratios’ is usually followed which has been suggested by the British Institute of Management. London

We know that a weak firm can compare its policy and performances with an efficient firm in the industry for the purpose of evaluating its position. In other words an weak or inefficient firm evaluates its own profitability and productivity by comparing data from an efficient firm.

The same is possible by inter-firm comparison through the application of ratio analysis. For this purposes various ratio are commonly used viz.. Management Ratio. Liquidity & Profitability Ratios etc



7. Centre for Inter-firm Comparison Ltd:

It has already been stated above that the Centre for Inter-firm Comparison was established in the year 1950 bv the British Institute of Management in collaboration with the British Productivity Council as an autonomous, independent and non-profit making body.

The primary objective of the centre was to supply the management ratios which were demanded by the trade and industry for the purpose of making inter-firm comparison. Thus, each member firm received a confidential report from the centre about its overall perfor­mances in comparison with other firms in the same line.

Management Ratios:

It is known to all that the success of a company is primarily measured by the amount of profit earned on its capital employed for a period. That is why the ratio of net profit to capital employed is known as ‘Primary Ratio.’

Although this ratio is used for the purpose of general management of a firm, other secondary or explanatory ratios are also to be taken into consideration. Now, we are going to highlight below a scheme of management ratios for inter-firm comparison which was suggested by the Centre for Inter-firm Comparison and which is known as ‘Pyramid of Ratios’.

From the ‘Pyramid of Ratios’ shown in the Fig 10.1, it is quite clear that the primary ratio is operating profit by operating assets or Return on Capital employed. Primary ratio is sub-divided into two which form the second step of ratio, viz.

(i) Operating Profit/ Sales and.

(ii) Sales/ Operating Assets.

Similarly, these ratios are further sub-divided into third or fourth step of ratios. It should be mentioned here that the first step is known as the primary ratio and the second step deals with the secondary ratio to the primary ratio.

Similarly, the third step expresses the general explanatory ratios and the forth step expresses the special explanatory ratios and these ratios are used by the member firms for the purpose of making comparison.

Pyramid of Ratios-Manufacturing Concern

Interpretation and Comments:

Why the ‘Pyramid of ratios’ differs from one firm to another that was explained by the Centre for Inter-Firm Comparison to the member firms. These explanations were supported by the Centre by supplying subsidiary data which were selected and taken into consideration as the same will affect such factors, e.g., plant capacity utilisation, labour turnover, size etc.

Thus, from the above discussion made so far, the following conclusion may be drawn up :

(a) An Inter-firm Comparison must contain a number of management ratios which help the member firm relating to : (a) their performances in comparison with the other firms, and (ii) the reason for such difference.

(b) The data so collected by the Centre must be comparable by the member firms.

(c) The reasons for difference between the ‘Pyramid of ratios’ and the ratios of the firm must be supplied by the Centre for Inter-Firm Comparison.

Use of Ratios:

The ratios which are divided in the scheme are divided into two:

(1) Primary Ratios;

(2) Secondary Ratios.

To sum up, following ratios which are usually followed by the Centre for Inter-firm Comparison are presented below.



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