व्हाट इज द सीरियस लिमिटेशन ऑफ रेशों एनालिसिस
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Answer:
Some of the most important limitations of ratio analysis include:
Historical Information: Information used in the analysis is based on real past results that are released by the company. Therefore, ratio analysis metrics do not necessarily represent future company performance.
Inflationary effects: Financial statements are released periodically and, therefore, there are time differences between each release. If inflation has occurred in between periods, then real prices are not reflected in the financial statements. Thus, the numbers across different periods are not comparable until they are adjusted for inflation.
Changes in accounting policies: If the company has changed its accounting policies and procedures, this may significantly affect financial reporting. In this case, the key financial metrics utilized in ratio analysis are altered and the financial results recorded after the change are not comparable to the results recorded prior to the change. It is up to the analyst to be up to date with changes to accounting policies. Changes made are generally found in the notes to the financial statements section.
Operational changes: A company may significantly change its operational structure, anything from their supply chain strategy to the product that they are selling. When significant operational changes occur, the comparison of financial metrics before and after the operational change may lead to misleading conclusions about the company’s performance and future prospects.
Seasonal effects: An analyst should be aware of seasonal factors that could potentially result in limitations of ratio analysis. The inability to adjust the ratio analysis to the seasonality effects may lead to false interpretations of the results from the analysis.
Manipulation of financial statements: Ratio analysis is based on information that is reported by the company in its financial statements. This information may be manipulated by the company’s management to report a better result than its actual performance. Hence, ratio analysis may not accurately reflect the true nature of the business, as the misrepresentation of information is not detected by simple analysis. It is important that an analyst is aware of these possible manipulations and always complete extensive due diligence before reaching any conclusions.
Explanation:
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Answer:
Once the financial statements of an organization are prepared they then need to be analyzed. One such tool to analyze and asses the financial situation of a firm is Ratio Analysis. It allows the stakeholder to make better sense of the accounts and better understand the current fiscal scenario of an entity. Let us take an in-detail look at ratio analysis.