What are the Limitations of ratio analysis

Answer Details

Limitations of ratio analysis

1. Based on historical (past) data: Ratios are computed from past financial statements and may not reflect the current or future position of the business.
2. Ignores price-level changes (inflation): Because figures are stated at historical cost, comparison over time can be misleading when the value of money is changing.
3. Affected by different accounting policies: Firms using different methods of depreciation, stock valuation, etc., cannot be fairly compared, and even one firm may change its policies.
4. Ignores qualitative and non-monetary factors: Ratios do not capture matters such as management quality, staff morale, government policy or market conditions.
5. Only as reliable as the accounts on which they are based: If the financial statements contain errors, window-dressing or manipulation, the ratios will also be misleading.
6. No single standard for interpretation: There is no universally accepted ideal figure for a ratio, so interpretation is often subjective and depends on the analyst.
7. A ratio in isolation has little meaning: Ratios must be compared with a standard, a budget, past years or other firms to be useful; one figure alone tells little.
8. Difficulty of inter-firm comparison: Differences in size, nature of business and accounting periods make comparison between firms unreliable.

(Any relevant limitations, well explained.)