Financial Statement Analysis : A Data Envelopment Analysis Approach

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 when two or more ratios provide conflicting signals. Indeed, ratio analysis is often criticized on the grounds of subjectivity, that is the analysts must pick and choose ratios in order to asses the overall performance of a firm.lt;brgt;lt;brgt;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 the managerial or operational efficiency of the firm. We test the null hypothesis that there is no relationship between DEA and traditional accounting ratios as a measure 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 the traditional ratio analysis. We illustrate the application of DEA to the oil and gas industry to demonstrate how financial analysts can employ DEA as a complement to ratio analysis.lt;brgt;lt;brgt;This paper was categorized as a theoretical paper by the editors of the Journal of the Operational Research Society. The algorithms used in the paper provided a basis for Invention Disclosure with the University of Minnesota Patent Office