what are the four limitations of using ratios and explanation of each
Answers
Answer:
ratio analysis information is historic – it is not current. ratio analysis does not take into account external factors such as a worldwide recession. ratio analysis does not measure the human element of a firm. ratio analysis can only be used for comparison with other firms of the same size and type.
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.Now, we have previously learned what ratios are. They are a comparison of two numbers with respect to each other. Similarly, in finance, ratios are a correlation between two numbers, or rather two accounts. So two numbers derived from the financial statement are compared to give us a more clear understanding of them. This is an accounting ratio.
Let us take an example. The income for the year from operations is let us say 1,00,000/- for a given year. The Purchases and other direct expenses cost around 75,000/-. So the Gross Profit of the year is 25,000/-. Now it can be said that the Gross Profit is 25% of the Operations Revenue. We calculate this as
G.P. Ratio =
G
P
S
a
l
e
s
/
R
e
v
e
n
u
e
×100
G.P.Ratio =
25
,
000
1
,
00
,
000
×100
G.P. Ratio = 25%
One factor to be kept in mind is that ratio analysis is used only to compare numbers that make sense and give us a better understanding of the financial statement. Comparing random financial accounts should be avoided.