The Widespread Wrong-Calculation and Wrong-Use of Central Financial Ratios

Financial return ratios are often miscalculated in textbooks and practice because denominators are frequently based on ending balance sheet values rather than taking the average of the capital base. While this may not distort simple intra-firm or intra-industry comparisons, it leads to a flawed understanding of profitability measures and can produce misleading conclusions when ratios are used for investment analysis, valuation, or cost-of-equity benchmarking. We document the extent of this problem by examining 112 accounting and finance textbooks, extending prior work by Mankin and Jewell [1]. Using major global beer industry firms, we illustrate how different denominator conventions materially affect return ratios and their alignment with stock returns and implied cost of equity. Our findings show that denominator choice significantly influences assessments of performance and value creation. We argue that accounting standard setters could reduce confusion by providing clear, prescribed definitions for key financial ratios in management commentary for instance regulated in IFRS 18, and thereby improving financial literacy and preventing systematic misinterpretation.