Fantasy vs. Reality in Financial Ratios

August 5, 2008

I apologize in advance if this post is a little wonkish, but I thought it was an issue important enough to warrant comment. I promise to return to my usually un-wonkish ways in future posts.

Myles Shaver and I wrote a paper several years ago in which we questioned the usefulness of a particular ratio - export intensity (click here for a copy of that paper). Export intensity is simply a ratio of export-to-total sales (expressed formally as export sales divided by total sales, where total sales is domestic sales plus foreign sales). Export intensity, you see, has become one metric by which researchers gauge the export performance of a firm. Our objection to this measure was that when export intensity increases, it can be difficult to determine whether that happens because export sales increase, domestic sales decrease, or some combination of the two (by mathematical construction, both end in the same result). Moreover, because export and domestic sales are interrelated, we must consider their joint impact on each other rather than artificially hold one (e.g., domestic sales) constant.

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