Abstract
Ratio analysis is a commonly used analytical tool for verifying the performance of a firm. While ratios are easy to compute, which in part explains their wide appeal, their interpretation is problematic, especially when two or more ratios provide conflicting signals. Indeed, ratio analysis is often criticized on the grounds of subjectivity, that is the analyst must pick and choose ratios in order to assess the overall performance of a firm.
In this paper we demonstrate that Data Envelopment Analysis (DEA) can augment the traditional ratio analysis. DEA can provide a consistent and reliable measure of managerial or operational efficiency of a firm. We test the null hypothesis that there is no relationship between DEA and traditional accounting ratios as measures of performance of a firm. Our results reject the null hypothesis indicating that DEA can provide information to analysts that is additional to that provided by traditional ratio analysis. We also apply DEA to the oil and gas industry to demonstrate how financial analysts can employ DEA as a complement to ratio analysis.
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Please do not quote without the permission of the authors. The algorithms used in this paper have provided a basis for Invention Disclosure with the University of Minnesota Patent Office.
Earlier versions of this paper were presented before the annual meeting of the Operational Research Society OR43; Accounting-Finance workshop of the University of Wisconsin-Milwaukee; Annual Meetings of the American Accounting Association, Dallas, Texas; Annual Meetings of the Financial Management Association, New York; and the Western Economic Association Meetings, Vancouver, B.C.
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Feroz, E., Kim, S. & Raab, R. Financial statement analysis: A data envelopment analysis approach. J Oper Res Soc 54, 48–58 (2003). https://doi.org/10.1057/palgrave.jors.2601475
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DOI: https://doi.org/10.1057/palgrave.jors.2601475