On the usefulness of standard industrial classifications in comparative financial statement analysis

It is shown that the comparison of the financial ratios between firms should be done with extreme caution even when the firms belong to the same official International Standard Industrial Classification category. A new measure of financial ratio closeness is developed in this paper. The homogeneity of each International Standard Industrial Classification category is established. This is done by comparing the homogeneity of the actual classification with a homogeneous clustering of the firms based on the new closeness measure. The empirical results based on all the Finnish publicly traded firms indicate non-homogeneity of the industry classification categories in terms of financial ratios.