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what can be a limitation of the accounting ratios for analyzing the financial statements

what can be a limitation of the accounting ratios for analyzing the financial statements

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Accounting Ratios:  They are a comparison of two numbers with respect to each other. It allows them to compare a company's financial performance and financial position across time and with its competitors.

Limitations of the accounting ratios for analyzing the financial statements are:

1. Financial statements are based on the historical concept and suffer from the limitation of not covering the inflation, the Accounting Ratios also suffers from the same because most of the ratios are calculated on the basis of information contained in financial statements. Different companies follow different financial reporting frameworks, which allow different accounting policies for identical transactions. In such a situation, it is important to adjust one company's financial statements.

2. Ratios are subjected to misinterpretation. Ratio analysis is based on information that is reported by the company in its financial statements. This information may be manipulated by the company’s management to report a better result than its actual performance.

3. Ratio provides only limited information. It useful only when the comparison is made between two companies from the same industries.

4. Ratio on its own will never be able to look into window dressing, if any, in the financial statements.

5. Ratios also fail to recognize the changes in accounting policies adopted by the firm.

6. Accounting ratios completely ignore the qualitative aspects of the firm.

7. Many ratios are calculated using historical costs, and they don't consider the changes in price level between the periods.

jeff jeffy answered 2 years ago
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