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ARJ
32,1 An IFRS-based taxonomy of
financial ratios
Thomas Zeller and John Kostolansky
Loyola University Chicago – Water Tower Campus, Chicago, Illinois, USA, and
20
Michail Bozoudis
Received 9 October 2017 Senior Cost Engineer, NATO Communications and Information Agency,
Revised 25 March 2018
Accepted 2 May 2018
Brussels, Belgium

Abstract
Purpose – This study aims to identify a taxonomy of financial ratios derived from financial statements
prepared using International Financial Reporting Standards (IFRS). The work first empirically establishes
and then statistically validates the taxonomy of financial attributes captured in financial ratios. In 2005, the
European Commission required that publicly traded companies in the European Union use IFRS as the basis
for financial reporting. In the same year, Australia adopted IFRS as a basis for financial reporting. Since then,
120 countries and reporting jurisdictions have adopted IFRS as the basis for financial reporting. Given that
IFRS predominate in the financial reporting world, it seems essential to establish and validate IFRS-based
ratio attributes. Only then can reliance upon and comparability of these ratios be warranted (Altman and
Eisenbeis, 1978). Using principle component analysis, the authors empirically identify nine stable attributes
(factors) for ratios drawn from IFRS-based financial statements from 84 counties. The findings provides an
empirical basis to formulate testable hypotheses regarding the predictive and descriptive utility of financial
ratios draw from IFRS-based financial statements.
Design/methodology/approach – The paper begins with a broad category of IFRS-based financial
ratios, 50, found in practice and research, including income statement, balance sheet, cash flow, profitability
and liquidity measures. Then, a sample of companies from the manufacturing sector is segmented using IFRS
as a basis of financial statement reporting. Next, principal component analysis, a method of factor analysis, is
applied to empirically identify factors and financial attributes captured in financial ratios used in research
inquiry and financial analysis.
Findings – The authors find that the financial attributes captured by IFRS-based ratios go well beyond the
traditional measures of profitability, liquidity and solvency. The authors identify nine factors that are
interpretable and stable over the period, 2011-2015: asset relationship, asset turnover, capital structure,
expense insight, fixed asset usage, inventory turnover, liquidity, profitability margin and performance return.
Interestingly, the authors did not find a separate cash flow factor. Most importantly, the results corroborate
that IFRS-based ratios are consistent and comparable, despite innate country differences that have been
shown to influence the application, interpretation and use of IFRS.
Research limitations/implications – The efforts are limited to the manufacturing sector. The financial
attributes may be different in service, distribution and retail sectors. Also, limiting the effort are the ratios
selected in this study. A broader range of ratios may widen the identification of unique stable factors over
time.
Practical implications – The findings provide a basis for research and analysis efforts regarding the
validity, comparability and stability of IFRS-based financial ratios. Most importantly, the results corroborate
that IFRS-based ratios are consistent and comparable, despite innate country differences that have been
shown to influence the application, interpretation and use of IFRS. The findings should be of interest to
international and national financial reporting standard setters, investors and analysts.
Originality/value – An empirically evidenced classification system for IFRS-based financial ratios has yet
to be determined based on a financial statements across a wide breadth of countries and reporting
Accounting Research Journal
Vol. 32 No. 1, 2019
pp. 20-35
© Emerald Publishing Limited The authors would like to thank anonymous reviewers for the many helpful comments in the review
1030-9616
DOI 10.1108/ARJ-10-2017-0167 process.
jurisdictions. Identification of stable interpretable factors, financial attributes, has been limited. The first is IFRS-based
that inquiry has been limited to domestic-based, such as US Generally Accepted Accounting Principles,
financial ratios. The second is inquiry has been limited to IFRS-based financial ratios within a specific taxonomy
country.
Keywords Factor analysis, Taxonomy, Financial reporting standards, IFRS-based financial ratios,
IFRS comparability, AASB research
Paper type Research paper
21
Introduction
This study first empirically establishes a taxonomy for financial ratios derived from
financial statements prepared using International Financial Reporting Standards (IFRS).
Next, this study statistically validates the taxonomy through stability analysis. Since
2005, when the European Commission required that consolidated financial statements of
publicly traded companies in the European Union (EU) be prepared using IFRS, over 120
countries and reporting jurisdictions have adopted the international standards. In the
same year, Australia was the first major economy to embrace IFRS (Pawsey, 2016). This
widespread adoption of IFRS was initially presumed to mean that, in additional to
national-based generally accepted accounting standards (GAAP), there was also a set of
high quality international standards for general use. It was presumed that IFRS financial
statements could be relied upon to have been prepared from a single set of standards that
had been interpreted in the same way by their preparers. Subsequent research has
revealed that variations exist in the application and interpretation of IFRS standards and
the research has attempted to measure the effect of these variations.
While an empirically-based taxonomy to classify financial ratios based on US GAAP has
been established and validated, similar work has yet to be attempted for IFRS-based ratios.
Without this validation, users of IFRS financial information can only presume that the
resulting financial ratios convey similar meaning from company to company and from
country to country. Initial IFRS research focused on the fundamental comparability of IFRS
information to that created under a respective national GAAP. The more fundamental issues
addressed in this paper are the identification and validation of IFRS-based ratio attributes
drawn from many countries and reporting jurisdictions. The goal of this study is to
empirically identify the taxonomy of financial ratio attributes captured under IFRS
reporting standards and examine the stability of those attributes over time. Only then is
reliance upon and comparability of financial ratios in research and analysis warranted
(Altman and Eisenbeis, 1978; Barnes, 1987).
To our knowledge, this is the first study to investigate IFRS-based financial ratio
attributes across countries and reporting jurisdictions over an extended period of IFRS
usage beyond the early implementation years. We find IFRS-based ratios provide insight
well beyond the traditional measures of profitability, liquidity and solvency. The findings
point to nine financial ratio attributes that are interpretable and stable. These attributes are:
asset relationship, asset turnover, capital structure, expense insight, fixed asset usage,
inventory turnover, liquidity, profitability margin, and performance return. The findings set
the stage to empirically test the information value provided by a wider set of respective
IFRS-based financial ratio attributes.
Also, these findings provide insight to those responsible for setting financial reporting
standards, internationally and nationally. This information is potentially relevant to the
International Financial Accounting Standards Board to either corroborate that IFRS-based
financial amounts are consistent and comparable despite innate country differences, or to
ARJ suggest areas for modification. Likewise this study may be of interest to national standard
32,1 setters who are deliberating IFRS adoption and quality.
Interest on the part of standard setters is evident from research reports commissioned on
their behalf. See, for example, The Impact of IFRS Adoption in Australia (2016), which was
undertaken on behalf of Australia’s Financial Reporting Council. Similar studies have been
commissioned by the Certified General Accountants Association of Canada (Blanchette
22 et al., 2011) following Canada’s adoption of IFRS in 2011 and by the Institute of Chartered
Accountants in England and Wales (ICAEW) (2015) following the adoption of IFRS by the
EU. Although the USA has determined to not adopt IFRS in the foreseeable future, the
Securities and Exchange Commission has reaffirmed its responsibility to develop a set of
high quality global standards (SEC Chair, Mary Jo White, public statement, 1/5/2017),
White, 2017. Clearly, there is keen interest in monitoring the multi-dimensional impact of
IFRS, which we believe extends to establishing and validating a taxonomy of IFRS-based
ratios.
The balance of this paper is organized as follows. The literature review will discuss
relevant IFRS research. Next the research design and sampling process are explained, the
sample and sample data are described and the findings are presented. The final section
offers a summary and conclusions.

Literature review
The advent of IFRS generated a body of accounting research that can be clustered into four
major categories. Initial research asked how IFRS-based amounts and ratios compared to
those computed under a specific country’s national GAAP (Barth et al., 2012). A second
stream of research investigated whether IFRS standards have been implemented similarly
in countries with differing cultural, legal, and accounting systems (Nobes, 2013 for a
thorough summary of this line of research). A third major path of research attempted to
measure the consequences, both intended and unintended, of mandatory adoption of IFRS
(See ICAEW Financial Reporting Faculty, 2015, for an excellent summary). Finally, an array
of studies explored corollary IFRS issues such as earnings management and accounting
quality differences (Evans et al., 2015).
Numerous studies have attempted to identify the specific effects upon the financial ratios
of companies in individual countries resulting from the adoption of IFRS. As such, these
studies serve to illustrate how IFRS amounts differed from those generated under previous
standards, but the studies do not address how IFRS amounts vary from country to country,
nor do these studies address the fundamental issue of what the ratios actually measure.
Consequently we reference a few of the key studies rather than an exhaustive list.
In a large sample study, Jones and Finley (2011) found that adopting IFRS resulted in a
significant reduction in the variability of post-IFRS ratios. Lanto and Sahlstrom (2009) found
that adopting IFRS significantly changed the value of key accounting ratios of Finnish
companies, while Ames (2013) found minimal change in South Africa. Blanchette et al. (2011)
found that most IFRS based ratios were significantly more volatile than those computed
using Canadian standards. Lueg et al. (2014) also found substantial differences in key
financial ratios under IFRS compared to UK GAAP. Barth et al. (2012) found that although
IFRS reporting in common law and high enforcement countries gained comparability to US
firms, significant differences remained. This diverse set of findings supports professional
accountants’ expectations that IFRS would create differences and raised an important
research question: what attributes are captured by ratios drawn from IFRS-based financial
statements? That is the purpose of the present study.
 Another line of inquiry investigated country-specific IFRS adoption issues. Most IFRS-based
accountants expected that IFRS would affect the amounts reported under various respective taxonomy
national GAAPs. However, it was unknown whether IFRS could be implemented uniformly
across countries with differing cultural, legal, and accounting systems. In an extensive
review of over 170 research papers, the ICAEW Financial Reporting Faculty (2015)
concluded there were improvements in transparency and comparability in the EU that were
uneven and incomplete. Jones and Slack (2013, p. 29) reported that “there remain concerns
23
over the actual level of this adoption in practice through financial reporting” and “there are
significant country differences.” Obradovic (2014) found that “a single global accounting
practice is still far from reality, i.e. the characteristics of the IFRS themselves, the procedure
of their incorporation into national regulatory frameworks and the weaknesses of national
incentive mechanisms create a room for diversity (variations) in the application of the IFRS.”
Nobes (2011) detailed the conditions and reasons for international variations in the use of
IFRS and in 2013 for the continued survival of IFRS international differences. Sherman and
Young (2016, p. 79) recently noted that the application of IFRS “varies widely from one
country to the next” and “that many countries have created their own versions of the IFRS
system by imposing “carve outs” (removal of offending passages) and “carve ins”
(additions) to the official standard.” Fifield et al. (2011) applied a three-country perspective
(UK, Ireland and Italy) to document that the impact of IFRS varies by country and to
suggest that future research consider using a multi-country approach. These studies again
raise the question posed by the present study: given the differences in application of IFRS,
what attributes are generally captured by ratios drawn from IFRS-based financial
statements?
The third path of IFRS research explored the intended and unintended consequences of
the mandatory adoption of IFRS. For example, Brüggemann et al. (2012) concluded in their
review of empirical literature that increased comparability and transparency were generally
not found although there was evidence of benefits in the capital markets. Piot et al. (2015)
found that conditional accounting conservatism actually decreased under IFRS despite the
principles-based nature of the international standards. Several studies found a positive
relationship between foreign direct investment and the mandatory adoption of IFRS
(Francis et al., 2016 and Gordon et al., 2012). Numerous studies found a positive relationship
between stock ownership in foreign companies and the mandatory IFRS adoption (Hong
et al., 2012; Florou and Pope, 2012, and Amiram, 2012). Yet other research focused on the
cost of capital. Hail and Leuz (2007), Palea (2007), and Daske et al. (2008) generally reported
reduction to the cost of capital after adopting IFRS, but the results were mixed and varied
significantly by country.
The final grouping of IFRS research explored important corollaries to IFRS adoption. In
illustration, Landsman et al. (2012) found that the information content of earnings
announcements increased in 16 countries that mandated IFRS relative to 11 countries that
did not. Hoque et al. (2016) established that gains in transparency resulting from mandatory
IFRS adoption were greatest in countries where financial secrecy was culturally imbedded.
Several before-and-after studies (Gebhardt and Novotny-Farkas, 2011; Leventis et al., 2011;
Ahmed et al., 2019; and Paanamen and Lin, 2009) reported mixed results on income
smoothing under IFRS. Interestingly, the research investigating the use of XBRL with
financial reporting has focused on the increased efficiencies for analysts, auditors, investors,
capital markets, and integrated reporting but not upon the information conveyed by
financial statement amounts and ratios. We think that this is the case because XBRL does
not change the underlying financial values of the financial data.
ARJ Only recently has research emerged that touched the taxonomy issue. Seay (2014)
32,1 detailed the key reporting differences between IFRS and US GAAP as reflected in the
financial ratios and quantified these differences using hypothetical statements. García Jara
et al. (2011) analyzed whether the quality of financial information captured by accounting
ratios was affected by the particular financial reporting standards chosen by companies.
Using a sample of 143 companies from 2005 to 2007 mainly listed on the Madrid stock
24 exchange. The study also aimed to “determine group factors that demonstrate the capacity
of ratios to measure accounting information quality” (p. 177). Consequently the results are
limited by geography and the use of early IFRS data which provided for a number of
mandatory exceptions. Although these studies explored how ratios have been affected by
the use of IFRS, they did not address the fundamental need to establish and validate a
taxonomy of IFRS-based ratios.

Research design
Data for this study were obtained from the COMPUSTAT Global database. Following
Gombola and Ketz, 1983 (G&K) we drew our sample from a single industry to reduce the
potential confounding that may result when running a principle component analysis on
financial ratios drawn from different industrial sectors. We used a two-stage process to limit
our sample to manufacturing companies reporting under IFRS. First, company data were
drawn from Global Industry Classification Standard (GICS) hierarch industry groups: 1,010
energy, 1,510 materials, 2,010 capital goods, 2,030 transportation, 2,510 automobiles and
components and 2,520 consumer durables and apparel, for those firms using IFRS for
external financial reporting during the five years’ period, 2011-2015. Next, the sample was
rationalized to companies falling within North American Industry Classification Codes
(NAICC) 31100 to 339999, the manufacturing sector. This second step was necessary given
our focus on the manufacturing sector and GICS organization by industry. Table I recaps
the global regions included in the sample.
The resulting sample contained 12,470 firm-years of data for companies on six
continents. The number of observations from Europe and Australia were relatively stable
since IFRS was adopted in both regions around 2005. On the other hand, the number of firms
represented from Asia has more than tripled during the five years of the sample as countries
in Asia were later to adopt IFRS. Given the diversity of the sample firms, the sample
provides a robust test of whether the use of IFRS generates financial values that measure the
same qualities across countries and regions of the world over time.
Table II lists the 50 ratios used in our study. These ratios represent a broad category of
IFRS based measures found in practice and research, including income statement, balance
sheet, cash flow, profitability and liquidity ratios. Given the exploratory nature of this study
we wanted to use a broad set of ratios to best capture the financial attributes within IFRS-

2011 2012 2013 2014 2015

Africa 55 62 69 68 83
Asia 469 1,097 1,190 1,491 1,568
Europe 887 880 872 874 852
North America (outside of USA) 174 184 192 226 232
Table I. Australia (Oceania) 71 66 66 69 71
Sample size by year South America 114 115 120 126 127
and continent Total 1,770 2,404 2,509 2,854 2,933
 IFRS-based
No. Ratio name Computation
taxonomy
1 Tax rate (Income taxes/Earnings before taxes)
100
2 R&D cost ratio (Research and development costs/Sales)
100
3 Cost of sales to total operating expense (Cost of sales/Total operating expense)
100
4 Depreciation and amortization to total (Depreciation and amortization/Total operating
operating expense expense)
100
5 Depreciation and amortization to sales (Depreciation and amortization/Sales)
100 25
6 Inventories to total capital (Inventories/Total assets or capital)
100
7 Degree of asset depreciation Accumulated depreciation on PPE/Historical cost of
PPE
8 Capex to depreciation and amortization (Capex, net/Depreciation and amortization)
100
9 Capex to sales (Capex, net/Sales)
100
10 EBIT margin (EBIT/Sales)
100
11 EBITDA (EBITDA/Sales)
100
Margin
12 Gross profit margin Gross profit/sales
13 Return on total capital [(Net income þ Income tax þ Interest expense, net
operating)/Total liabilities and shareholders' equity]
100
14 Return on equity (Net income excl. extraordinary items)/(Total equity)
100
15 Return on average total assets (Net income/Average total assets)
100
16 Return on capital employed (ROCE) (EBIT/(Fixed assets, net þ Working capital))
100
(Used average for denominator)
17 Return on investment (ROI) (Net income/Sales)
(Sales/Total liabilities and
shareholders' equity)
100
18 Return on sales (Net income/Sales)
100
19 Cash flow margin (Cash flow from operating activities/Sales)
100
20 Working capital to sales (Working capital/Sales)
100
21 Sales to inventory Sales/Average total inventories
22 PPE to sales (PPE/Sales)
100
23 Fixed asset turnover Depreciation on PPE/Average PPE at historical costs
24 Current asset turnover Sales/Average current assets
25 Total asset turnover Sales/Total assets
26 Receivables turnover Sales/Average trade receivables
27 Days sales outstanding (Average trade receivables/Sales)
365
28 Days payables outstanding (Average trade liabilities/Cost of sales)
365
29 Inventory turnover Cost of sales/Average total inventories
30 Capital turnover Sales/(Total equity þ Total liabilities)
31 Equity Ratio (Total equity/Total capital)
100
32 Total liabilities to total capital (Total liabilities/Total capital)
100
(leverage)
33 Total liabilities to total equity (gearing) (Total liabilities/Total equity)
100
34 Leverage structure [(Trade liabilities þ Short-term liabilities)/Total
Liabilities]
100
35 Dynamic gearing Net debt/Free cash flow
36 Quick ratio ((Total current assets  Total inventory)/Total current
liabilities)
37 Current ratio (Total current assets/Total current liabilities)
38 Asset structure (Fixed assets/Current assets)
39 Asset intensity (Fixed assets/Total assets)
40 Total current assets to total assets (Total current assets/Total assets)
41 Financial strength (Cash flow from operating activities/Payments for non- Table II.
current assets)
100 Ratios used in
42 Reinvestment rate (II) (Depreciation of PPE/Additions to PPE, net)
100 financial analysis
(continued) and research
ARJ
32,1 No. Ratio name Computation

43 Depreciation rate (Depreciation of PPE/PPE at year end)
100

44 Fixed assets to total equity Fixed assets/Total equity
45 Golden financing rule (Total equity þ Long-term liabilities)/Fixed assets
46 Equity to assets ratio (Total equity þ Long-term liabilities/Fixed assets)
100
26 47 Current liabilities to sales (Current liabilities/Sales)
100
48 Receivables to short-term liabilities (Receivables/Short-term liabilities)
100
49 EBIT to short-term liabilities (EBIT/Short-term liabilities)
100
Table II. 50 EBIT interest coverage EBIT/Interest expense (income), net operating

based financial statements. This step follows a similar approach taken by G&K and others
working to empirically identify attributes captured in financial ratios.
Principal component analysis (PCA), a method of factor analysis used in prior studies
dating back to Pinches and Mingo (1973), was again used in the present study. This technique
remains today to be one of the best and most appropriate statistical techniques for this analysis.
G&K pointed out that, “Factor analysis requires no distributional assumptions, allowing usage
of non-normally distributed ratios. Also, because no decision model is specified, the variables
are not required to take any particular distribution or forms.” Thus, we followed G&K and did
not perform log transformations on the data. This approach increases the generalizability of
our results. We retain in our sample firms with negative as well as positive earnings. The
differences in order of magnitude among the ratios is addressed by using a correlation matrix,
rather than a variance-covariance matrix in the PCA. These steps enhance consistency and
enabling comparability with prior and future studies.
To begin, we ran the Bartlett’s Test of Sphericity to confirm the validity of conducting
factor analysis for each year of the ratio data sets. The test evaluates the hypothesis that the
correlation matrix is an identity matrix. We find the p-values are less than 0.1 per cent for
each year, thus rejecting the null hypothesis of an identity matrix at the 1 per cent
significance level. Table III shows the results, along with respective sample size per year.
Given the reasoned correlation among the ratios, we proceeded to identify the factors.
Selecting the number of factors is a blended analytical process (Laurent, 1979; O’Connor,
2000; Gordon and Courtney, 2013). A factor was considered to be stable if the same ratios
loaded to that respective factor in each year of our study. We appraised the PCA output
against four extraction criteria, a substantial improvement over prior studies, which
generally used only a single criterion, Kaiser’s eigenvalues-greater-than-one in their
selection process. Table IV identifies the four extraction criteria, along with their respective
advantages and disadvantages.

Bartlett’s test of sphericity

Year Sample size p-value (required < 1%)

2011 1,770 <0.1

Table III. 2012 2,404 <0.1
Sample size and 2013 2,509 <0.1
Bartlett's test of 2014 2,854 <0.1
sphericity 2015 2,933 <0.1
Consistent with Pinches et al. (1973) and others, we required ratios to load at an absolute IFRS-based
value of 0.7 or greater to be considered. Similar to G&K, we disregarded factors comprised taxonomy
of a single ratio. Last, we evaluated the stability of a factor over time with a congruency
coefficient defined by Harman (1976, p. 344) and used by G&K and Zeller, Kostolansky and
Bozoudis (2016). According to Jensen (1998), Lorenzo-Seva and ten Berge (2006); and Abdi
(2007), a congruency coefficient above 85 per cent indicates “fairly similar” factors.
27
Research findings
Table V identifies the average number of factors and the explained variance under
different extraction criteria. The measures provide an objective overview across factor
extraction methodologies, serving as a starting point for the next step of our analysis –
to identify stable, interpretable factors across time. We investigated factor models with
10, 11, 12, 13 and 14 factors extracted for each year from 2011 to 2015. We required two
or more ratios with a factor loading having an absolute value of 0.7 or greater as a
criteria for naming a factor. We identified factors comprised of ratios loadings at less
than 0.7 as “Unknown.”
Over the period from 2011 to 2015, we identified 16 factors using the 12-factor model
(Table VI). We found that the 12-factor taxonomy model provided the most meaningful
insight, with a 67 per cent mean explained variance. We held the analysis to the same
number of factors each year, which is a condition for performing the congruency
analysis (discussed below). With the 10- and 11-factor models, a combination of ratios
loaded in ways that confounded factor interpretability. With the 13- and 14-factor
models, factors consisting of a single ratio emerged, thus reducing interpretability due
to over-extraction.
Nine (highlighted in gray) of the factors were interpretable and stable over the period,
2011-2015: asset relationship, asset turnover, capital structure, expense insight, fixed asset
usage, inventory turnover, liquidity, profitability margin, and performance return. The
remaining factors were not interpretable or stable or both.

Factor extraction criteria Advantages Disadvantages

Total Explained Variance Flexible Subjective

Kaiser, also known as Objective, set to simple predefined Typically overestimates, and
eigenvalues great then 1 limit sometimes underestimates the
(K1 or EV > 1) number of components (Zwick and
Velicer, 1986). Components not
always reliable (Cliff, 1988)
Velicer’s Minimum Statistically based Errs in under extraction
Average Partial (MAP) According to O’Connor (2000), “focus
test is on the relative amounts of
systematic and unsystematic
variance remaining in a correlation
matrix”
Horn’s Parallel Analysis Statistically based Errs in over extraction
(PA) According to O’Connor (2000), “focus
is on the number of components that Table IV.
account for more variance than the Factor extraction
components derived from random criteria advantages
data” and disadvantages
ARJ Table VII lists the congruency coefficient for the nine stable factors. The interpretation of a
32,1 congruency coefficient is analogous to a correlation coefficient. The congruency coefficient
for the stable factors ranges from 0.73 to 0.98. These factors surfaced each year of the study
and are correlated year to year, providing empirical evidence that six of the nine factors are
“fairly similar,” for the period from 2011 to 2015. The factors are: asset relationship, capital
structure, expense insight, fixed asset usage, inventory turnover, and liquidity. Three factor
28 congruency coefficients fall slightly below the “fairly similar” range, asset turnover at 0.75,
profitability margin at 0.73 and return performance at 0.78 per cent.
Tables VI and VII guide our discussion and conclusion about the individual factors and
the ratios. The evidence suggests nine stable financial attributes captured in the 50 general
use ratios. We find the financial attributes captured by IFRS-based ratios go well beyond the
traditional measures of profitability, liquidity and solvency. Analysts and researchers may
wish to use Ratios loading to respective factors from 2011 to 2015, all years at > 0.7, unless
indicated as a guide for selecting appropriate IFRS ratios to answer questions related to the
respective factors. Likewise, future researchers may wish to determine why many

2011-2015 average
Criterion No. of factors (%) of explained variance

Per cent of Explained Variance: > 70% 14.0

Table V.
Per cent of Explained Variance: > 75% 16.4
Average number of Per cent of Explained Variance: > 80% 19.0
extracted factors and Kaiser (EV > 1) 17.0 77
per cent of explained Velicer (MAP) 12.6 67
variance Horn (PA) 13.2 69

Factors identified in alphabetical order 2011 2012 2013 2014 2015

Stable, identifiable factors highlighted

Asset relationship X X X X X
Asset turnover X X X X X
Capital employed X X X
Capital expenditure X
Capital structure X X X X X
Expense insight X X X X X
Fixed asset usage X X X X X
Inventory turnover X X X X X
Liquidity X X X X X
None X X X X
Profitability margin X X X X X
Profitability margin 1 X X X
Receivable/payable management X
Return performance X X X X X
Unknown 1 X X X
Unknown 2 X
Total extracted factors 12 12 12 12 12
Table VI. Total explained variance(%) 70 65 65 66 67
The 12-factor model,
2011-2015 Note: Mean explained variance = 67%
conventionally used ratios do not consistently correlate with the other ratios in their IFRS-based
presumptive factor. IFRS standard setters may wish to commission research to determine if taxonomy
the lack of correlation of some ratios is the result of country-specific difference in the
application of IFRS or business practices, or other causes. Further research is necessary to
determine the information value of the identifiable factors, beyond simple profitability,
liquidity and solvency attributes.
(1) Asset relationship 29
 Asset intensity
 Asset structure*
 Total current assets to total assets

(2) Asset turnover

 Capital turnover
 Current asset turnover
 Total asset turnover

(3) Capital structure

 Non-current assets to total stockholders’ equity
 Total liabilities to total equity (gearing)

(4) Expense insight

 Cost of sales to total operating expense
 Depreciation and amortization to total operating expense

(5) Fixed asset usage

 Depreciation rate*
 Fixed asset turnover*

(6) Inventory turnover

 Inventory turnover
 Sales to inventory

(7) Liquidity
 Accounts receivable to current liabilities
 Current ratio
 Quick ratio

Factor Mean congruency coefficient for stable factors, 2011-2015

Asset relationship 0.94

Asset turnover 0.75
Capital structure 0.96
Expense insight 0.98
Fixed asset usage 0.91
Inventory turnover 0.97 Table VII.
Liquidity 0.93 Mean congruency
Profitability margin 0.73 coefficients for stable
Return performance 0.78 factors
ARJ (8) Profitability margin
32,1  EBIT margin
 EBITDA/Sales

(9) Return performance

 Return on average assets*

30  Return on investment
 Return on total capital*

*Loaded to factor in 4 of 5 years at > 0.7, 1 of 5 years at < 0.7. An individual discussion of
the nine stable factors follows.

Asset relationship
Ratios loading to respective factors from 2011 to 2015, all years at > 0.7, unless indicated
identifies the three ratios that drive the asset relationship factor: asset intensity, asset
structure, and total current assets to total assts. The evidence suggests the relationship
among current, long-term and total assets captures a unique financial attribute about a
company’s asset structure. Tables VI and VII demonstrate that this attribute is highly
stable, surfacing each year from 2011 to 2015, and fairly similar over this period with a mean
congruency coefficient at 0.94. Further research is necessary to determine the information
value of this factor to decision-making.

Asset turnover
Three ratios, capital turnover, current asset turnover, and total asset turnover, comprise this
factor (Ratios loading to respective factors from 2011 to 2015, all years at > 0.7, unless
indicated). We surmise that the efficiency in employing assets and capital to generate sales
represents a unique financial attribute. A higher level of turnover represents higher
efficiency of business operations, as greater sales are generated with the given amount of
company assets. Tables VI and VII demonstrate that this attribute is highly stable,
surfacing each year from 2011 to 2015, and slightly less than fairly similar over this period
with a mean congruency coefficient at 0.75.

Capital structure
Ratios loading to respective factors from 2011 to 2015, all years at > 0.7, unless indicated
shows two ratios drive this factor: non-current assets to total stockholders’ equity and total
liabilities to total equity (gearing). The evidence suggests that the relationship between non-
current assets and equity is similar to the relationship between total liabilities and equity,
perhaps because non-current assets are often financed with long-term debt. Thus the two
variables may be closely related. Management’s propensity to use long-term financing to
acquire assets seems to be captured by the connection between these two ratios. This
attribute persistently surfaced each year from 2011 to 2015 (Table VI) and is fairly similar
with a mean congruency coefficient at 0.96 (Table VII). Further research is necessary to
determine its information value to decision-making.

Expense insight
Ratios loading to respective factors from 2011 to 2015, all years at > 0.7, unless indicated
shows two ratios drive this factor: cost of sales to total operating expense and depreciation
and amortization to total operating expense. The evidence suggests the relationship among
cost of sale, depreciation and amortization, and total operating expenses represent a unique IFRS-based
financial attribute. Relatively high levels of cost of sales and depreciation and amortization taxonomy
in relation to operating expenses may be endemic to manufacturing and represent an
important attribute to manage and control. Substantively reducing depreciation and
amortization can only be achieved by increased efficiency in the use of assets. As a business
goes through cycles of product introduction, growth and decline, the relative costs of sales
and fixed resources necessary to support the product increase and decrease respectively.
This attribute surfaced in each year of the study, exhibiting stability, and is fairly similar
31
with a mean congruency coefficient at 0.98. Our understanding of the information value of
the expense insight factor requires additional research.

Fixed asset usage

Ratios loading to respective factors from 2011 to 2015, all years at > 0.7, unless indicated
shows two ratios drive this factor: depreciation rate and fixed asset turnover. Logically, the
two ratios are connected in that the depreciation rate is tied to the amount of fixed assets on
hand and the fixed asset turnover ratio is a measure of the efficiency of the use of fixed
assets. The evidence suggests the relationship among depreciation expense, gross fixed
asset at historical cost, and net fixed asset additions represents a unique financial attribute.
The fixed asset usage attribute surfaced all five years of the study and is fairly similar with
a mean congruence coefficient at 0.91.

Inventory turnover
Two ratios drive the inventory turnover factor: inventory turnover and sales to inventory.
Logically, the ratios of cost of sales to inventory and sales to inventory will exhibit a strong
relationship so long as the gross profit margin on sales is stable. Tables VI and VII
demonstrate that this attribute is highly stable, surfacing each year from 2011 to 2015, and
fairly similar over this period with a mean congruency coefficient at 0.97.

Liquidity
Ratios loading to respective factors from 2011 to 2015, all years at > 0.7, unless indicated
shows three ratios drive this factor: accounts receivable to current liabilities, current ratio
and quick ratio. Tables VI and VII demonstrate that this attribute is highly stable, surfacing
each year from 2011 to 2015, and fairly similar over this period with a mean congruency
coefficient at 0.93. This finding confirms the long-standing attribute of liquidity captured in
financial ratios.

Profitability margin
Ratios loading to respective factors from 2011 to 2015, all years at > 0.7, unless indicated
shows two ratios drive this factor: EBIT margin and EBITDA margin. The ratios of EBIT to
sales and EBITDA to sales were proven to be reliable and consistent measures of profitability.
The attribute is stable, surfacing each year from 2011 to 2015 (Table VI). While the profitability
margin factor mean congruency coefficient is slightly less than fairly similar at 0.73.

Return performance
Ratios loading to respective factors from 2011 to 2015, all years at > 0.7, unless indicated
shows three ratios drive this factor: return on average assets, return on investment and
return on total capital. Tables VI and VII demonstrate that this attribute is highly stable,
surfacing each year from 2011 to 2015, and slightly less than fairly similar over this period
ARJ with a mean congruency coefficient at 0.78. Note that both the profit margin and return
32,1 performance factors exhibited a lower congruency than the other factors, perhaps due to the
volatility of income measures. Further inquiry is necessary to investigate the economic
conditions explaining the lower mean congruency coefficients.
Ratios that did not consistently load to a factor deserve comment. IAS 7 (International
Accounting Standard 7) mandates a statement of cash flows is designed “to assess the
32 ability of the entity to generate cash and cash equivalents and the needs of the entity to
utilize those cash flows.” We found the cash flow margin ratio loaded to the profit margin
factor in only three of the five years. The ratio loaded to a secondary operating performance
factor in one year and in another year loaded to an unknown factor. We interpret the
inconsistent loading as evidence that the cash flow margin ratio is not a reliable measure of
the cash content of sales. In addition we found the other cash flow ratios, dynamic gearing
and financial strength, did not load to any factor at >0.7, and did not load consistently to
any factor at less than 0.7. This finding leads us to conclude that the IFRS cash flow
measures are inconsistent and to question if the Statement of Cash Flows is actually
providing its intended information. This question deserves further research inquiry.
The congruency levels, Table VII, point to a question about measurement stability. The two
factors associated with income statement measures, profit margin and return performance,
have congruency measures at 0.73 and 0.78, respectively. In contrast, the factors associated
with the balance sheet have higher congruency measures at >0.91. This finding raises a
question about IFRS-based measures that deserve future research: are balance sheet measures
more stable than income statement measures? Income measures are by nature volatile due to
swings in the business cycle and/or changes in an individual company’s management or
fortunes. In addition, the fair-value accounting option under IFRS adds to the income volatility.
Balance sheets are inherently more stable as increases or decreases in assets generally take
time to materialize and are relatively smaller. Likewise, liabilities often follow the changes in
assets. Nonetheless, our study points to significantly lower congruency for income statement
measures relative to balance sheet measures. It is beyond the scope of this study to definitively
explain why the difference in stability exists for these measures.

Summary and conclusion

This study was conducted to establish and validate a taxonomy for IFRS-based financial
ratios. Given that IFRS predominate in the financial reporting world, it seems essential to
establish, validate, and measure the strength and stability of classifications of IFRS-based
ratios. Although a significant body of research was generated following the 2005 adoption of
IFRS by the EU, Australia and others, that research did not attempt to establish a taxonomy
as has been done for US-GAAP-based financial ratios.
Using principle component analysis over the five-year period from 2011 to 2015, we
found that the taxonomy of IFRS-based ratios consists of nine interpretable and stable
attributes. The financial attributes are: asset relationship, asset turnover, capital structure,
expense insight, fixed asset usage, inventory turnover, liquidity, profitability margin and
performance return. Future research is necessary to identify the information value provided
by these factors beyond the widely recognized asset turnover, liquidity, profitability and
performance return factors. Unlike previous studies of US-GAAP-based ratios and despite
the prominence of the IFRS cash flow statement, a stable cash flow attribute did not surface
in this study. The generalizability of our findings is wider than those previous studies that
limited their sample to only those firms reporting all the requisite data for all years of the
study. Similarly, since a log transformation on the ratios is unnecessary for PCA, we were
not forced to drop negative ratios or guess about a ‘best’ transformation approach, again IFRS-based
achieving greater generalizability of our findings. taxonomy
Our findings provide a basis for research and analysis efforts regarding the validity,
comparability, and stability of IFRS-based financial ratios. Most importantly, our results
corroborate that IFRS-based ratios are consistent and comparable despite innate country
differences that have been shown to influence the application, interpretation, and use of
IFRS. Major studies undertaken by international organizations working in the public
33
interest (ICEAW 2015, Australia FRC 2016, and CGA, Canada 2011) employed data from the
early years of IFRS adoption. This study improves upon these studies by incorporating
recent IFRS data subsequent to the 2008 global financial crisis and absent the initial
adoption issues faced before 2008. Thus, standard setters may be interested to note these
results in comparison to those previous studies. In addition, the findings indicate which
ratios consistently measured a particular attribute over time, which may provide guidance
to users in choosing particular ratios for decision-making. Standard setters and accounting
professionals may wish to use these results to direct future research and to guide any
discussions of modification of standards.

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Corresponding author
Thomas Zeller can be contacted at: [email protected]

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