Regression Analysis v. Ratios in the Cross-Section Analysis

The assumption that the calculation of a ratio generates a useful number is widespread among analysts. The recent literature on financial statement analysis has highlighted this assumption and has raised doubts about its validity on both theoretical and empirical grounds. The empirical studies of Mc...

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Bibliographic Details
Published inAccounting and business research Vol. 21; no. 82; p. 107
Main Authors Berry, R H, Nix, S
Format Journal Article
LanguageEnglish
Published Abingdon Taylor & Francis Ltd 01.04.1991
Subjects
Financial statement analysis
Mathematical models
Ratios
Regression analysis
Studies
Variables
United Kingdom > UK
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Summary:The assumption that the calculation of a ratio generates a useful number is widespread among analysts. The recent literature on financial statement analysis has highlighted this assumption and has raised doubts about its validity on both theoretical and empirical grounds. The empirical studies of McDonald and Morris (1984, 1985) are presented as supporting the continued use of the ratio form. Using UK data on the brewing industry, the 4 ratios chosen by McDonald and Morris were examined, along with a 5th - the ratio of stocks to sales. The results offer little support for the findings of McDonald and Morris. Their analytical approach did not generate similar results for another industry for the ratios they examined. The analysis of the additional variable pairing stock and sales clearly contradicted their general conclusion. An assumption-free, exploratory method of analysis is therefore desirable. It is shown that one such approach is the exploratory use of regression.
ISSN:0001-4788
2159-4260