Analysis of Financial Statements Page 1

ANALYSIS OF FINANCIAL STATEMENTS:

Ratios are indicators which are used for analysis of Financial

Statements. Ratios indicate weak and strong areas of the firm. Ratios
show the trend of activities (same business) either rising or falling as
compared to preceding / previous years. Ratios can be used carefully
because sometimes it may lead to wrong conclusion.

 Analysis of company’s financial statements is performed by the

following:

 Interest parties outside the business who are seeking to know more about
the company (potential investors).
 Management wishing to interpret their company’s past performance in
order to make improvements for the future.

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 Limitations of Financial Ratios
• (1) Ratios are based on accounting figures given in the financial statements. However,
accounting figures are themselves subject to deficiencies, approximations, diversity in
practice or even manipulation to some extent. ...
• (2) Ratios have inherent problem of comparability. Companies otherwise similar may
employ different accounting methods, which can cause problems in comparing certain
key relationships. ...
• (3) Inflation may limit the utility of accounting ratios. Due to inflation, historical cost-
based financial statements and accounting figures do not reflect current value figures,
especially in the case of ...
• (4) Accounting ratios are not totally dependable and they must be used after giving due
weight- age to general economic conditions, industry situation, position of firms within
the industry, mode ...
• (5) The different methods of computation also influence the utility of accounting
ratios. ...
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