Balance sheet can be compared with report card of students, just as report card it shows the marks of student and the performance of student over the year. In the same way balance sheet shows the performance of company over the year, however balance sheet cannot be considered as something which is without any limitation. Lets looks at some of the limitations of balance sheet –
- The first and foremost of limitation of balance sheet is that it does not take into account qualitative factors into consideration. Qualitative factors like health of director or chairman of the company, working conditions of employees in the company, relation of company with creditors and debtors, internal atmosphere within the company etc… will not be reflected in the balance sheet of the company, although all these qualitative factors have huge role to play in the success or failure of the company.
- Second limitation of balance sheet is that it is dependent on data entered in journal and ledger because balance sheet is prepared from ledger books and hence if there is any mistake at the time of entry in journal and ledger then balance sheet will also carry these mistakes and hence will not reflect the true picture about the financial position of the company.
- Another limitation of balance sheet is that it is not conclusive enough to take decision regarding the company and one need to look at other financial statements like cash flow and fund flow statement and ratios like price to earnings and earnings per share along with balance sheet to decide whether the company is financially strong or not. In simple words balance sheet alone is not conclusive enough to take decisions regarding the company.
- Balance sheet is prepared at the end of the financial year and hence if there is anything wrong with financial position of the company in terms of performance or if there is any fraud then balance sheet will reflect it only at the end of financial year when most of the damage has happened and therefore complete trust on balance sheet can lead to disaster as balance sheet is static in nature and not dynamic.
- In balance sheet chances of manipulations are high because there are so many things which can be adjusted in the balance sheet so for example fixed asset are shown in the balance sheet at historical cost and not at market price, closing stock may be valued according to FIFO or LIFO method according to market conditions, similarly deprecation method is prone to manipulation as companies sometimes change from straight line to written down method or vice versa. In accounting this is called as window dressing and one should keep this aspect in mind before taking any decision purely on the basis of balance sheet.
As one can see from the above that balance sheet has many limitations and one should keep above limitations in mind before taking any decision about the company, still balance sheet is still one of the most trusted and widely used financial statement all over the world and its importance in depicting the financial position of the company cannot be undermined.