LIMITATIONS OF RATIO ANALYSIS

1. Using one ratio result might not be very helpful. To allow comparison,
comparison must be made with other businesses (inter firm comparisons) or
with other time periods (trend analysis)
2. Inter firm comparison is more effective when companies in the same industry
are being compared. This is because changes in the economic environment may
have an adverse impact on a company publishing its accounts in June compared
to those publishing it in January.
3. The trend analysis takes into account the changing circumstances over time that
can affect the ratio results. Some factors are outside the company’s control
4. Some ratios can be calculated by using different formulas. This can give different
results
5. Businesses have different ways of valuing their assets and they use different
methods of depreciation. This is also done as a deliberate manipulation or
window dressing of the accounts of a company.
6. Ratios are measured from numerical data. However, many analysts are now
becoming more concerned about the non-numerical aspects of business
performance.
7. The ratios are very useful analytical tools. However, they do not solve business
problems of underperformance. Ratio analysis can be used to highlight problems
but they do not indicate the true cause of business problems.

Limitations of annual reports and published accounts

The following details are not published:

 Details of sales and profitability of each company’s products and divisions

 The research and development plans of the business and any proposed new
products
 The details of future plans for expansion or rationalisation
 Evidence of the company’s impact on the environment and local community

Other limitations are:

 Only historic data is included. This might not be a good indicator of future
performance
 Intangible assets are rarely fully valued in the accounts
 The accounts are not always comparable with other companies as they might be
using different valuing or depreciating methods
 The accounts might not be accurate
 Only two years of accounting data have to be included in the report.