limitation of ratio analysis

Topics: Economics, Financial ratio, Finance Pages: 2 (540 words) Published: April 18, 2014
Limitations of Ratios used for analysis:
1.Inflation will distort a firm’s balance sheet and a trend analysis may not give a true picture of the firm’s financial performance. 2.Different fiscal year, example, a firm may have a fiscal year that ends on June 30, whereas another company in the same industry may have a fiscal year ends on 31 . 3.Financial analysis is performed on historical data mainly for the purpose of forecasting future performance. The historical relationships may not continue because of changes in the general state of the economy, the business environment in which the entity must operate, or internal factors such as change in management or changes in the policies established by management. 4.Year- end data may not be typical of the entity’s position during the year. Knowing that certain ratios are calculated at year-end, management may attempt to improve a ratio by entering into certain types of transactions near the end of the year. For example, the current ratio can be improved by using cash to pay off short term debt. Also, if the financial year-end

Limitations of Ratios used for analysis:
1.Inflation will distort a firm’s balance sheet and a trend analysis may not give a true picture of the firm’s financial performance. 2.Different fiscal year, example, a firm may have a fiscal year that ends on June 30, whereas another company in the same industry may have a fiscal year ends on 31 . 3.Financial analysis is performed on historical data mainly for the purpose of forecasting future performance. The historical relationships may not continue because of changes in the general state of the economy, the business environment in which the entity must operate, or internal factors such as change in management or changes in the policies established by management. 4.Year- end data may not be typical of the entity’s position during the year. Knowing that certain ratios are calculated at year-end, management may attempt to improve a ratio...
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