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Limitations of financial ratio analysis
- Many ratios are calculated on the basis of the balance-sheet figures. These figures are as on the balance-sheet date only and may not be indicative of the year-round position.
- Comparing the ratios with past trends and with competitors may not give a correct picture as the figures may not be easily comparable due to the difference in accounting policies, accounting period etc.
- It gives current and past trends, but not future trends.
- Impact of inflation is not properly reflected, as many figures are taken at historical numbers, several years old.
- There are differences in approach among financial analysts on how to treat certain items, how to interpret ratios etc.
- The ratios are only as good or bad as the underlying information used to calculate them.
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