Advantages

1. It simplifies the financial statements.

2. It helps in comparing companies of different size with each other.
3. It helps in trend analysis which involves comparing a single company over a period.
4. It highlights important information in simple form quickly. A user can judge a company by
just looking at few numbers instead of reading the whole financial statements.
5. Financial statement analysis. Accounting ratios are useful for understanding the financial
position of the company. Different users such as investors, management. Bankers and
creditors use the ratio to analyze the financial situation of the company for their decision
making purpose.
Limitations
Despite usefulness, financial ratio analysis has some disadvantages. Some key demerits of
financial ratio analysis are:
1. Many large firms operate different divisions in different industries. For
these companies it is difficult to find a meaningful set of industry-
average ratios.
2. Inflation may have badly distorted a company's balance sheet. In this
case, profits will also be affected. Thus a ratio analysis of one company
over time or a comparative analysis of companies of different ages must
be interpreted with judgment.
3. Seasonal factors can also distort ratio analysis. Understanding seasonal
factors that affect a business can reduce the chance of
misinterpretation. For example, a retailer's inventory may be high in the
summer in preparation for the back-to-school season. As a result, the
company's accounts payable will be high and its ROA low.
4. Different accounting practices can distort comparisons even within the
same company (leasing versus buying equipment, LIFO versus FIFO,
etc.).
5. It is difficult to generalize about whether a ratio is good or not. A high
cash ratio in a historically classified growth company may be interpreted
as a good sign, but could also be seen as a sign that the company is no
longer a growth company and should command lower valuations.
6. A company may have some good and some bad ratios, making it
difficult to tell if it's a good or weak company.