Meaning of Inter-Firm Comparison:
Inter-firm comparison is the technique which studies the performances, efficiencies, costs and profits of various concerns in an industry with the help of exchange of information in order to have a relative comparison.
It involves the process by bringing together a number of identical firms and collecting their business figures and statistics through a neutral organisation in which the participating firms repose their full confidence.
The firms are carefully screened and put into different size groups, their figures examined from a close range, comparative performance of each firm of the group drawn up showing the strong and weak points of its operations, and finally the reports are published without disclosing their identity, but using only codes and expressed in terms of certain well established ratios and percentages.
The figures under comparison may relate to:
From the above it is clear that the main objectives of inter-firm comparison are:
Requirements of an Inter-Firm Comparison Scheme:
Following are the main requirements while installing a scheme of inter-firm comparison:
i. Adaption of Uniform Costing:
There must be a sound system of uniform costing in the firm where inter-firm comparison scheme is to be implemented. A uniform manual should also be prepared and distributed among the member units to enable the function of the system efficiently.
ii. Organisation Responsible:
An organisation must be established to run the system efficiently and for better results firms of different sizes in an industry should become member of the organization. In industrially advanced countries independent agencies such as British Centre for Inter-firm Comparison, European Productivity Agency and U.S. Bureau of Labour Statistics are responsible for collection, coordination and presentation of information but in India some undertakings such as National Productivity Council, the Trade Development Authority, the Bureau of Industrial Costs and Pricing, the Tariff Commission have undertaken though in a limited way the task of inter-firm comparison.
In some cases trade associations, holding company or parent organisation are doing this work.
iii. Information to be Collected:
The nature of information to be collected from the participating firms depends upon the needs of the management, comparative importance of the information and the efficiency of the central body responsible for the collection of the information.
The information to be collected must be relevant only. Information is generally collected relating to costs and cost structure, labour or machine efficiency and utilisation, raw material consumption, wastage, inventory, return on capital employed, liquidity, reserves and appropriation of profit, methods of production, creditors and debtors, technical aspects etc.
iv. Method of Collection and Presentation of Information:
The time and the form in which the information is to be submitted by the member units must be decided in advance. The various statistical tools for the purpose of collection of data, its editing, classification, presentation, drawing conclusions and inferences can be used. Ratio analysis for measuring profitability, efficiency and productivity etc. can also be used.
Advantages of Inter-Firm Comparison:
Inter-firm comparison is nothing more than learning by example. It is for the management that inter-firm comparison has been evolved as a technique in industry. From the point of view of the working of a particular firm, it is at times impossible to know what is happening outside and why.
Inter-firm comparison by an expert outside body affords suitable knowledge, satisfying to a large extent the need for management to know what the competitors in the line are doing and how.
To the workers and their unions, inter-firm comparisons help to give an idea of the relative capacity of the firms in question in terms of wages and the wage scales, production bonus, increasing the possibilities of employment etc. as well as the relative efficiency of the workers in a particular firm vis-a-vis other firms in the same industry, the same area, or the same class of workers.
It can help management to make effective divisions at strategic and operating levels.
Following are the main advantages of inter-firm comparison besides what have been stated in the advantages of uniform costing:
Prof. Nigam has beautifully summarized, the utility of inter-firm comparison in these words:
“It is not only useful for management, it also acts as a tool for decision making by bankers, shareholders, institutional investors, licencing authorities, price control organisations, creditors, trade unions, consumers’ organisations and other social and economic interests. It is also useful in evaluating business results and return on capital invested which, in turn, helps in project appraisal and evaluation, conducting feasibility studies, capital budgeting, investment decisions etc”.
Following limitations of inter-firm comparison may be noted:
These limitations can be removed by proper education and propaganda. This may be done through articles in the journals and periodicals, lectures, seminars and personal discussions. There must be an installation of a system which ensures complete secrecy. Introduction of a scientific cost system is needed in order to provide reliable information relating to the various aspects for comparison purposes.
Ratios of Inter-Firm Comparison:
Ratios used in the inter-firm comparison are of four types:
(i) Primary Ratios
(ii) Supporting Ratios
(iii) General Explanatory Ratios
(iv) Specific Explanatory Ratios
All the ratios can be taken together to form a pyramid as given below:
In addition to above ratios, some other ratios may be used for the purpose of systematic analysis of operational results. These cover all aspects of business activities and are meant for measurement of effectiveness of the resources.
These additional ratios are briefly explained below:
(A) Ratios of Performance Measurement:
1. Value of Direct Material/Value of Production
2. Cost of Materials/Quantity Produced
3. Cost of Scrap / Cost of Raw Material
4. Quantity of Scrap / Quantity of Raw Material
5. Cost of Rejection / Cost of Production
6. Total Output / No. of Workers
7. Cost of Production/Machine Hours or Labour Hours
8. P.V. Ratio i.e., Contribution x 100/Sales
9. Contribution / Labour Hours
10. Wages/No. of Workers
11. Total Fringe Benefits/No. of Workers
12. Idle Time / Total Time
13. Overtime Hours / Total Labour Hours
14. Standard Hours for Actual Production / Actual Hours
15. Actual Hours / Budgeted Hours
16. Power Cost / Machine Hours
17. Repair and Maintenance Cost / Cost of Production
18. Advertising Cost / Selling Cost
(B) Ratios to Judge Profitability:
These ratios show how profitable are company’s operations.
1. Gross Profit Ratio i.e., (GP/Sales) ×100
2. Net Profit Ratio i.e., (NP / Sales) × 100
GP ratio indicates manufacturing or trading efficiency while NP ratio shows overall profitability
3. Return on capital employed i.e., Profit / Capital employed
ROLE indicates overall performance from the stand point of profitability. It is primary ratio in the pyramid of ratios
(C) Ratios related to Turnover:
Turnover Ratio show how efficiently company is managing current assets.
1. Stock turnover ratio i.e., cost of sales/Average stock
This ratio shows the efficiency of inventory management. Average stock is average of opening and closing stock
2. Debtors Turnover Ratio i.e., Debtors * Days or Months in a year / Annual Credit Sales
Debtor’s turnover measures the efficiency in collection of debts
3. Creditors Turnover Ratio i.e., (Creditors x No. of days of months in a year)/Annual Credit Purchases.
This ratio measures the efficiency of purchase department in realizing credit facilities
(D) Liquidity Ratios:
These ratios show the liquidity position of the company to meet its day to day needs of working capital
1. Current Ratio i.e., Current Assets/Current Liabilities
Current Ratio shows the ability of the company to meet its maturing current liabilities. An ideal ratio is 2:1 but it may differ due to nature of business.
2. Quick Ratio or Acid Test Ratio i.e., Quick Assets i.e., Current Assets excluding inventory/ Current Liabilities
Quick Ratio indicates ability of the company to meet its immediate current liabilities out of readily realizable current assets.
The central body collects and analysis the data supplied by participating firm, calculates relevant ratios and prepares report to be sent to individual member firm. Normally code numbers are used in place of names of the firms so that information may remain confidential. The results and interpretations are presented in the report in such a way that individual firm data could not be identified.
On receipt of the comparative data and report of inter-firm comparison, it is the job of the management of the firm to compare operating and other results and the corresponding ratios with ratio furnished by the central body of IFC.
Advantages of Inter-Firm Comparison:
1. Under IFC the weakness of participating firms are revealed and the management will be guided to remedial actions.
2. The firm will come to know the trend of sales, profit and cost of an industry or trade as shown by different ratios. If all firms are suffering from falling sales, it will be indicated by sales to capital or asset employed ratio. When an individual firm compares its own ratio with the ratio of the group, it will see that there are general reduction sales.
3. Management of participating firm are provided with most significant facts on the basis of ratios carefully selected by the central body. The firm will have to do only the study of the ratios and the necessary action.
4. Whether firm is doing better or worse than other firms is made known through the ratios. The firm can take positive steps to improve efficiency.
5. The experience of the central body is at the disposal of participating firms. This knowledge can be very valuable in the analysis of performance and profitability of the firm.
6. Participating firm provide information willingly knowing that this remains confidential.
7. IFC develops cost consciousness among participating firm.
8. IFC leads to avoidance of unfair competition. It guides in the direction of proper and positive efforts towards improvement of performances.
9. Inter-firm comparisons and related data help in representing the problem of the industry to regulating authorities and the Government in an effective and convincing matter. Information regarding entire industry can be presented before the Government and not the isolated problem of individual firm.
10. Collective information provided under IFC can help the industry in its negotiations with trade unions.
Limitations of IFC:
It is obvious that inter-firm comparison is useful in improving productivity, efficiency and profitability. But benefits are obtained only when ratios are properly calculated and impartially used. The limitations of ratio analysis should be taken into consideration. It should be noted that a single ratio is of a limited value and their trend is most important. Moreover the limitation of uniform costing should also be taken into consideration because uniform costing provides the very basis of inter-firm comparison
It should also not be ignored that certain extraneous factors such as prolonged strike, power shortage may also adversely affect the performance of the industry in a particular period. Limitations and short comings of annual returns and data may also affect the reliability of conclusions.
It can also be pointed out that there are practical limitation in the formation and maintenance of an independent central agency for inter-firm comparisons. The cost of introducing uniform costing may make the management of firm reluctant to participate in a scheme of inter-firm comparison.