Limitations of Ratio Analysis

 Limitations of Ratio Analysis

Limitations of  Ratio Analysis

1. Financial Statement suffer from a number of limitations. When the ratios are constructed from those financial statements, ratios suffer from the inherent weakness of the accounting system itself.

2. By using ratios, forecasts of future of a business may not prove correct. This is because, ratio are all based on past happenings and not future probabilities. They are subject to change in the future.

3. Accounting ratios are simply clues. They not indicate the causes of difference. Therefore, they are not considered as basis for immediate conclusion.

4. The accounting ratios change with the change in the operating results which give misleading information.

5. Ratios are not free from individual bias, because accounting is man-made. Two identical business units with the same level of operation and investment may show highly incomparable financial results.

6. There is lack of proper standard for ideal ratios. There are many rules of thumb, since it is not possible to establish well accepted absolute standard.

7. While constructing accounting ratios, arithmetic window dressing is possible by concealing vital facts and presenting the financial statements in such a fashion as to show the business in a better position than it actually is.