Classification pattern of financial ratios; a comparative analysis between US and Finnish firms on the aggregate level

Paavo Yli-Olli and Ilkka Virtanen

Summary

The purpose of this study was first to develop, on an aggregate level, using large Finnish firms quoted on the Helsinki Stock Exchange 1974 - 84, an empirically-based classification pattern for twelve commonly used financial ratios. Second, to compare whether the methodological choices made in the research by Yli-Olli and Virtanen (1985) can get empirical evidence in this research. Third, to measure the structural invariance of the financial ratio pattern between the US and Finnish firms.

The selected ratios were, according to literature, the measures of short-term solvency, long-term solvency, profitability and efficiency of the firms. The empirically- based classification was not fully equivalent to the a priori classification (US firms). We found the following factors: solvency, profitability efficiency and dynamic liquidity (Yli- Olli and Virtanen 1985).

An interesting result was that we found a very similar factor pattern when Finnish data were used. However, the factor pattern was similar only when we used the first differences of the value-weighted averages of the ratios. Certainly, when the first differences of equal-weighted indices were used, the classification pattern also appeared to be to some extent acceptable as far as the Finnish data were concerned. After that we analyzed, using transformation analysis, the long-term stability and structural invariance of the factor patterns obtained. The resulting factor pattern - based on value weighted averages of the selected ratios (in the difference form) - displayd very clear time series stability and strong structural invariance between US and Finnish data. On the other hand, the results gave evidence of considerable instability and slight structural invariance when the variables were equal-weighted indices. Equal-weighted averages were especially sensitive both for outliers and for the heterogeneity in the data. These results confirmed the great importance of aggregation method in the financial ratio analysis when we use aggregate data.

(The Finnish Journal of Business Economics, 2- 1986, 112-132)