Ratio analysis is a very
important technique used in both small and big companies. It provides
businessmen the information required to analyze their company’s growth in the
industry. Financial ratio analysis is all about comparisons. However, there are
few limitations in using ratio analysis.
Incorrect Standard
Ratio analysis benchmarks to the
standards set by leaders and not the industry. This might seem different from all that is thought. However, think
about the topic. Are you concerned about the performance of your company or the
market? Or, do you aim for average results? Everyone wants high performance.
But, ratio analysis stresses on average rations and not the best performers.
Heavy Inflation
It is quite interesting to note
that most balance sheets are distorted by heavy inflation. The balance sheets
are filled with historical data. When you look back at the balance sheets, you
will see only past details. These figures will be completely different from the
real ones. When you compare information from balance sheets and make your
ratios, everything will be distorted.
Mere
Numbers
Ratio analysis is all about
numbers and not the root cause. There are several ways to calculate ratios. If
you don’t find the actual reason behind the numbers, you are doing a useless
and meaningless job. And, there is no meaning in playing this useless game with
ratios and old industry data. Ratio analysis differs from one industry. You
need to compare with all the
divisions in mind. This is when ratio analysis represents something important.
Ratio analysis is based on
hard-core facts. This means firms can manipulate it to suit their needs. Also,
the statement doesn’t represent seasonal fluctuations. Most firms use ratio
analysis as a window for amending their financial values and interpretations. So,
if firms need better values in their annual report – they can work on the ratio
analysis report.
Moving on, ratio analysis gives a
very small and limited view of the company. It doesn’t describe the business
and its performance completely. There are so many other factors to judge the
overall growth and performance of a company. This includes staff relationship,
monopoly positions and morale.
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