FINANCIAL RATIOS

The financial ratios are ways of comparing and investigating the relationships between different pieces of financial information. Critically discuss the limitations of using the Financial Ratio Analysis

Financial Ratios

Introduction

While financial ratio investigation can supply us with significant insight into a company's presentation, a good financial analyst will be cognizant that there are some important limitations that should be documented when utilizing financial ratios as an analytical device in financial modeling. 

 

Limitations of Financial Ratio Analysis

Ratio investigation is a retrospective, not potential examination.

Ratio investigation is founded on accounting not financial data.

Ratios don't arrest important off-balance sheet items.

Financial declaration accounts contemplate chronicled cost not inevitably present financial value.

Cash flow assesses have been verified to be more nearly correlated with supply cost action that earnings founded measures.

Accounting Information Different Accounting Policies

The alternatives of accounting principles may falsify inter business comparisons. Example - IAS 16 permits valuation of assets to be founded on either revalued allowance or at depreciated chronicled cost.

Creative accounting

The enterprises request creative accounting in seeking to display the better financial presentation or place which can be deceptive to the users of financial accounting.

Information difficulties  Ratios are not definitive measures

Ratios require to be understood carefully. They can supply signs to the company's presentation or financial situation. But on their own, they will not display if presentation is good or bad. Ratios need some quantitative data for an acquainted investigation to be made.

Outdated data in financial statement

The numbers in a set of accounts are probable to be not less than some months out of designated day, and so might not give a correct suggestion of the company's present financial position.

Financial declarations comprise summarized information

Ratios are founded on financial declarations which are abstracts of the accounting records. Through the summarization some significant data may be left out which could ...