Limitations of Ratio Analysis

Ratio analysis can be used to make comparisons with past performance or other firms to assess the financial performance and status of a company, and in planning. But care has to be taken to ensure a meaningful comparison is made. This relies on:

• A thorough understanding of the rules and conventions underlying the presentation of financial statements.
• Comparison of representative years or periods of trading.
• Uniform or standardised preparation of ratios.
• Thorough investigation of the underlying causes or explanations of the results of the analysis.