Limitations of Ratio Analysis
Though ratio analysis is an important tool for analyzing the financial statements of the company and has many advantages, however it has certain limitations. Let’s look at some of the limitations of the ratio analysis –
1. While ratio analysis can be great for comparison between companies, however if there is only one company then ratio analysis can be misleading.
2. Since ratio analysis is done from the data in the financial statements like profit and loss and balance sheet, in case of any mistakes in those financial statements will reflect in the ratios also.
3. Since Ratios are easy to manipulate they are misused by managers for window dressing; window dressing refers to presenting of better picture of the company than what it is.
4. Ratio analysis does not take into account the qualitative factors; it only presents the figures as they are. So for example it may possible that company may have higher current ratio indicating that liquidity position of the company is good, however if large portion of those current asset includes inventory then it does not mean a sound liquidity position.
5. Ratios are not same for everybody that is different people have different perception regarding the ratios. So a current ratio of 2:1 may be good for some people, however some people may think it is not adequate.