Inter-firm comparison

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Cambridge O Level Accounting 7707

Inter-firm Comparison

The big idea: Comparing your ratios with another business in the same trade shows whether you are doing well or just doing the same as last year. But two businesses are never measured in exactly the same way, so every comparison comes with warnings.

Summary — What This Chapter Covers

Inter-firm comparison sets one business’s ratios beside another’s (or an industry average) for the same period.
Use ratios, not raw figures: a bigger business always has bigger figures.
Problems: different accounting policies, sizes, year ends, locations and trades, historic cost figures, limited published information, non-financial factors.

1. Applying Ratios to Two Businesses

Syllabus 6.3 · Paper 1 & 2

Compare like with like

Northgate Stores has the larger revenue and profit, but the question is which business uses its resources better. Ratios remove the effect of size.

Two retailers, year ended 30 June 2026
	Northgate Stores $	Southside Stores $
Revenue	240,000	160,000
Gross profit	84,000	64,000
Profit for the year (no interest)	30,000	28,000
Capital employed	200,000	140,000
Current assets (including inventory)	40,000	27,000
Inventory	22,000	9,000
Current liabilities	20,000	15,000

Worked example

Calculate the gross margin, profit margin, ROCE, current ratio and liquid ratio for each business, and state which is performing better.

Ratio	Working (Northgate \| Southside)	Northgate	Southside
Gross margin	84,000 ÷ 240,000 × 100 \| 64,000 ÷ 160,000 × 100	35.00%	40.00%
Profit margin	30,000 ÷ 240,000 × 100 \| 28,000 ÷ 160,000 × 100	12.50%	17.50%
ROCE	30,000 ÷ 200,000 × 100 \| 28,000 ÷ 140,000 × 100	15.00%	20.00%
Current ratio	40,000 ÷ 20,000 \| 27,000 ÷ 15,000	2.00 : 1	1.80 : 1
Liquid ratio	18,000 ÷ 20,000 \| 18,000 ÷ 15,000	0.90 : 1	1.20 : 1

Southside is more profitable on every measure: it earns more gross profit per $100 of sales and a higher return on the money invested. Both spend 22.50% of revenue on expenses (35.00 − 12.50 and 40.00 − 17.50), so the whole profit margin gap comes from Southside’s higher gross margin. Northgate’s current ratio is higher only because of its large inventory; its liquid ratio of 0.90 : 1 is below 1, so Southside is also more liquid.

Practice Question 1

A supplier is deciding which of two businesses to give 60 days’ credit. Business X: current ratio 0.9 : 1, trade payables turnover 75 days. Business Y: current ratio 1.8 : 1, trade payables turnover 35 days. Advise the supplier.

2. Problems of Inter-firm Comparison

Syllabus 6.3 · Paper 1 & 2

Why the comparison may mislead

Problem	Why it matters
Different accounting policies	One business uses straight-line depreciation, the other reducing balance; inventory may be valued differently. Profits and asset values are not measured the same way.
Different size	A large business gets bulk discounts and spreads its expenses; a small one cannot.
Different year ends	Seasonal trade: inventory and receivables at 31 December differ from 30 June.
Different type of business or location
Historic cost
Different definitions
Only one year

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7707 Jun 2026 · Paper 1 · Variant 2 Cambridge · mark scheme Open → 7707 Jun 2025 · Paper 1 · Variant 2 Cambridge · mark scheme Open → 7707 Jun 2024 · Paper 1 · Variant 2 Cambridge · mark scheme Open → 7707 Jun 2023 · Paper 2 · Variant 2 Cambridge · mark scheme Open → 7707 Jun 2021 · Paper 1 · Variant 2 Cambridge Open →

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Inter-firm comparison