Limitations of Ratio Analysis

Although Ratio Analysis is a very useful accounting tools to analyze and interpret different accounting equations, it comes with its own set of limitations:

●      If the data received from financial accounting is incorrect, then the information derived from ratio analysis could not be reliable.

●      Unauthenticated data may lead to misinterpretation of ratio analysis.

●      Future prediction may not be always dependable, as ratio analysis is based on the past performance.

●      To get a conclusive idea about the business, a series of ratios is to be calculated. A single ratio cannot serve the purpose.

●      It is not necessary that a ratio can give the real present situation of a business, as the result is based on historical data.

●      Trend analysis is done with the help of various calculated ratios that can be distorted due to the changes in the price level.

●      Ratio analysis is effective only where same accounting principles and policies are adopted by other concerns too, otherwise inter-company comparison will not exhibit a real picture at all.

●      Through ratio analysis, special events cannot be identified. For example, maturity of debentures cannot be identified with ratio analysis.

●      For effective ratio analysis, practical experience and knowledge about particular industry is essential. Otherwise, it may prove worthless.

●      Ratio analysis is a useful tool only in the hands of an expert.

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