Question

2. Briefly discuss the potential limitations with ratio analysis and additional qualitative factors that analysts will consider beyond ratios when evaluating a company.

Answer 1

Solution:

The potential limitation with the ratio analysis

1. Ratio analysis is qualitative analysis, it calculates only based on the numbers on the financial statements. It only explains the changes in value quantitatively, it does not explain what caused them.

2. There could be various reasons like the slowdown in the economy, cyclicity, technological advancement etc that can impact the ratios heavily. Ratio analysis cannot explain that.

Qualitative factors that an analyst can consider are-

1. The growth of the nation: GDP growth can impact the financial statements of the company so an analyst should see the trend of GDP

2. Industry growth: How the particular industry is doing also impacts the company performance so one needs to see that as well.

3. Cyclicity: There are various industries that are cyclic in nature hence an analyst should factor that as well

4. Future Forecast: What is the future forecast for the company as well as the industry can play a big role in the future performance of the company

5. technological advancement: This can lower the cost so various ratios can improve like Gross profit margins. So analyst needs to see how this impact the company

There can be many other qualitative factors but these are some of the important factors.