At a recent training session, we ran the company’s numbers, did the analysis and found some large percentage increases and decreases in a number of categories. Participants wanted to know if the changes indicated positive or negative performance.
Rather than giving the normal answer to every financial analysis question (i.e., it depends), we traveled down relativity road. In other words, what story do the numbers tell us? While the percentages might be large, what was the relative importance of each change? How did the numbers drive the company’s results? How did the company’s numbers compare to the market place, competition and Wall Street expectations? What did the numbers illustrate about overall trends?
A “perfect” example of how percentages can be deceptive is found when one does win projections for America’s favorite football team, the Cleveland Browns (OK, they may not be America’s favorite team, but — mostly for worse, especially around the BLI offices — they’re mine). Last year, as most long-suffering Cleveland fans would like to forget, the team posted another 4-12 record and fired their coach and front office.
One could make a strong argument that a 25% improvement would be an excellent number. But, relative to other teams, if the Browns won 25% more games, they’d post five victories. A 50% improvement in wins would mean the Browns’ record would only be 6-10. A 100% improvement in wins gets Cleveland to 8-8, the definition of mediocre.
As the Browns, alas, illustrate, it’s critical to look at any change relative to previous performance, the market place and the competition. While a 50% improvement sounds fantastic, if comparable companies are posting 75% gains, it might indicate the company is missing out on a favorable market trend. The converse is also true: a 10% drop in sales looks great if competitors sales have all fallen 25%. Always remember that ratios are tools that need to be used in combination with other tools. Use them to read the story of what the numbers are telling you.
Of course, given the team’s anemic performance in recent years, 5-11 sounds pretty good to a Cleveland Browns fan.