Answer to Question #53171 in Accounting for habiba

Question

Discuss the limitations of financial ratios in using them to evaluate business.

Answer 1

There are limitations of financial ratios. There is a significant art in the interpretation of ratios.
1) Ratios are only as informative as the financial statements on which they are based.
2) Ratio analysis is probably most accurate for organizations with a narrow line of products or services.
3) Inflation can distort the financial statements.
4) With some ratios it is difficult to tell where a ratio value changes from “good” to “bad.”
5) It is sometimes very difficult to draw overall conclusions about an organization using ratios alone.
6) Differences in accounting assumptions may make it difficult to compare ratios from different organizations.
7) Differences in ratio definitions may make it difficult to compare ratios from different sources.