Why can't ratio analysis be a sole indicator of how well a business is doing?

Expert Solution

Ratio analysis is important but it cannot be a sole indicator of business's well doing because they work best when supported with good amount of information from the company's financials or data for peer companies to validate a comparison. Ratio analysis indicates broad trendings and may not tell causation for such a trending alone. One is supposed to be beating about the bush if one is required to tell about business's well being solely through ratio. Infact, ratios are meaningless without comparison against trend data or industry data. For example, ratios may show a different picture unless someone incorporates information about inflation. Even so, different companies may use different accounting standards to value their inventory or depreciation methods and so on. Ratios may give a distorted view if not accounted for these factors. Hence, we can say ratios can aid in indicating well being of business only when accompanied by other essential information.

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