Chapter 3, Problem 1QTD

Summary Introduction

To discuss: Limitations of ratio analysis as a measure of financial statement analysis.

Explanation of Solution

The limitations of the ratio analysis are as follows,

• Ratios cannot be calculated effectively when the numerator and denominator have opposite signs.
• If denominator can be zero, then the interpretation of ratios is meaningless.
• It may not capture the changing strategy of the company, and hence an analyst could miss the crucial changes in the enterprise design.
• It cannot be useful for better understanding during extraordinary periods like a period of low growth or high growth.
• Ratios can be used as a standalone figures, this must have used previous year’s ratios for comparison purposes.