Before comparing two ratios, check two things: do they cover the same period, and do they use the same definition? If either answer is no, the comparison is unfair.
This lesson is part of performance beyond one ratio. It extends explaining limitations of one-period comparisons.
How do I check a comparison is fair?
Ask two questions about every pair of ratios.
- Period: is each figure for the same length of time and the same part of the year?
- Definition: is each ratio worked out with the same formula?
If you cannot confirm both, say so, and recalculate from the raw figures where you can.
Worked example: two shops with the same label
Two fictional shops report to a school business club. Both sales figures are RM120 000 for the year.
Shop X reports “profit margin 30%”. Shop Y reports “profit margin 12%”. Shop X looks much stronger.
Check the definitions. Shop X’s 30% is gross profit ÷ sales, since its gross profit is RM36 000. Shop Y’s 12% is net profit ÷ sales, since its net profit is RM14 400. The labels match, and the formulas do not.
Recalculate both on the same basis. Shop Y’s gross profit is RM48 000, so its gross margin is 48 000 ÷ 120 000 = 40%. Shop X’s expenses are RM25 200, so its net profit is 36 000 − 25 200 = RM10 800, a net margin of 9%.
| Gross margin | Net margin | |
|---|---|---|
| Shop X | 30% | 9% |
| Shop Y | 40% | 12% |
Conclusion. On a fair basis Shop Y is stronger on both measures. The first comparison had the winner the wrong way round.
The fairness check changed the answer, so it is not a formality.
The mistake that costs marks
The common slip is to compare the two percentages as printed.
| Step | Wrong | Right |
|---|---|---|
| Read | X 30%, Y 12% | X 30% (gross), Y 12% (net) |
| Check | none | definitions differ |
| Recalculate | not done | gross 30% and 40%, net 9% and 12% |
| Verdict | X is stronger | Y is stronger on both |
If two labels look the same, check the formula behind each.
Check yourself
Shop P reports a 15% margin for March. Shop Q reports a 10% margin for the whole year.
Both use net profit ÷ sales. Is it fair to say P is more efficient? What would you ask for?
Answer
The definitions match, but the periods do not. A single month and a full year are different situations, and March may include a busy or quiet season.
It is not fair to conclude that P is more efficient. Ask for P’s margin for the full year, or for Q’s margin for March, so the periods match.
What to study next
Go on to identifying which additional statement would clarify a problem. Then try the integrated practice set.
The business case answer planner can hold a fairness check in your answer layout. For a teacher to work through comparisons with you, see online one-to-one Business tuition.