Introduction to Limitations of Ratio Analysis
Even though ratios present a quick and useful method of analysing the position and performance of a business, they are not without their limitations and problems. We shall now reconsider some of the shortcomings of financial ratio analysis.
Quality of financial statements
It must all the time be kept in mind that ratios are based on financial statements. So, The results of ratio analysis are dependent on the quality of these underlying statements. Ratios will take over the limitations of the financial statements on which they are relies. As we saw earlier that one significant limitation of financial statements is their failure to involve all resources controlled through the business. Internally produced goodwill and brands, for instance, are not included from the statement of financial position since they fail to meet the strict definition of an asset. The meaning of this is that, although these resources might be of considerable value, key ratios like ROSF, ROCE and the gearing ratio will fail to acknowledge their existence.
There is also the difficulty of deliberate attempts to create the financial statements misleading.
Inflation
However, a persistent currently less severe problem in most countries is that the financial results of businesses can be distorted like a result of inflation. One influence of inflation is that the reported value of assets held for any length of time might bear slight relation to current values. Usually, the reported value of assets will be understated in current terms throughout a period of inflation because they are generally reported at their original cost (less any amounts written off for depreciation). The meaning of this is that comparisons, either among businesses or among periods, will be hindered. A variation in, say, ROCE might just be owing to the fact that assets displayed in one of the statements of financial position being compared were attained more recently (ignoring the influence of depreciation on the asset values). Other effect of inflation is to distort the measurement of profit.
Sales revenue is frequently matched with costs acquired at an earlier time in the calculation of profit. This is since there is frequently a time lag among acquiring a specific resource and using it to help produce sales revenue. For instance, inventories might well be attained various months before they are sold. Throughout a period of inflation, this will mean that the expense does not reflect prices that are present at the time of the sale. The cost of sales figure is generally relies on the historic cost of the inventories concerned. The result, expenses will be understated in the income statement and this, in turn, means that profit will be overstated. One influence of this will be to distort the profitability ratios discussed before.
The restricted view given by reliance on ratios
It is significant not to rely exclusively on ratios, thus losing sight of information consisted in the underlying financial statements. As we described earlier some items reported in these statements can be important in assessing position and performance. For instance, the total sales revenue, capital employed and profit figures might be helpful in assessing changes in absolute size that happen over time, or in assessing variations in scale among businesses. Ratios do not give such type of information.
While comparing one figure with other one, ratios measure comparative performance and position and so give only part of the picture. While comparing two businesses, so it will frequently be helpful to assess the absolute size of profits, and the relative profitability of each business. For instance, Business A might produce £1 million operating profit and have a ROCE of 15% and Business B may produce £100,000 operating profit and have a ROCE of 20%. Even though Business B has a higher level of profitability, as computed by ROCE, it produces lower total operating profits.
The basis for comparison
We consider before that if ratios are to be helpful they need a basis for comparison. Furthermore, it is significant that the analyst compares like with like. In which the comparison is with other business, there can be problems. No two businesses are similar. The greater, the variations among the businesses being compared, the greater are the limitations of ratio analysis. Additionally, any variations in accounting policies, financing methods (gearing levels) and financial year ends will add to the problems of making comparisons among businesses.
Ratios relating to the statement of financial position
Since the statement of financial position is only a 'snapshot' of the business at a specific moment in time, any ratios relies on statement of financial position figures, like the liquidity ratios, might not be representative of the financial position of the business for the year like a whole. For instance, it is general for a seasonal business to contain a financial year end that coincides along with a low point in business activity.
Latest technology based Financial Accounting Online Tutoring Assistance
Tutors, at the www.tutorsglobe.com, take pledge to provide full satisfaction and assurance in Limitations of Ratio Analysis homework help via online tutoring. Students are getting 100% satisfaction by online tutors across the globe. Here you can get homework help for Limitations of Ratio Analysis, project ideas and tutorials. We provide email based Limitations of Ratio Analysis homework help. You can join us to ask queries 24x7 with live, experienced and qualified online tutors specialized in Limitations of Ratio Analysis. Through Online Tutoring, you would be able to complete your homework or assignments at your home. Tutors at the TutorsGlobe are committed to provide the best quality online tutoring assistance for Financial Accounting homework help and assignment help services. They use their experience, as they have solved thousands of the financial accounting assignments, which may help you to solve your complex issues of Limitations of Ratio Analysis. TutorsGlobe assure for the best quality compliance to your homework. Compromise with quality is not in our dictionary. If we feel that we are not able to provide the homework help as per the deadline or given instruction by the student, we refund the money of the student without any delay.
www.tutorsglobe.com offers coordination compounds homework help, coordination compounds assignment help, online tutoring assistance, inorganic chemistry solutions by online qualified tutor's help. coordination compounds
www.tutorsglobe.com offers human resource essay writing assignment help, hrm report writing help, hrm writing assignment help, homework help.
tutorsglobe.com regulation of testicular function assignment help-homework help by online functioning of male reproductive system tutors
economic efficiency and key concepts of economic efficiency, transfer price, price ceiling, technical efficiency, invisible hand and bankruptcy, answering questions by managerial economics tutors, homework help, assignment help.
Essentials of a good costing system - Costing system that is adopted in any organization should be appropriate to its nature and size of the business and its information requirements.
tutorsglobe.com occurrence and principles of extraction of copper assignment help-homework help by online first transition series tutors
www.tutorsglobe.com offers carboxylic acids homework help, carboxylic acids assignment help, online tutoring assistance, organic chemistry solutions by online qualified tutor's help.
Seriously, nobody would claim that accounting information completely meets all of the requirements of each of the several user groups.
tutorsglobe.com life cycle of a phage assignment help-homework help by online viruses tutors
www.tutorsglobe.com offers the general ledger homework help, the general ledger assignment help, accounting online tutoring, ans preparing general ledger based question's answers.
tutorsglobe.com reproduction assignment help-homework help by online human physiology tutors
introduction practical chemistry i tutorial all along with the key concepts of apparatus, volumetric analysis, standardization of non-standard solution
Theory and lecture notes of Aggregate Supply and Phillips Curve all along with the key concepts of aggregate supply, phillips curve, Three Faces of Aggregate Supply, Okun’s law. Tutorsglobe offers homework help, assignment help and tutor’s assistance on Aggregate Supply and Phillips Curve.
Phyla Mollusca and Echinodermata tutorial all along with the key concepts of Features of Phyla Mollusca and Echinodermata, Adaptations and Development, Classification of mollucs, Features of Echinoderms and Symmetries of Echinoderms
leaves of nicotiana tabacum (tobacco) consist of alkaloids nicotine, nornicotine and anabasine.
1934379
Questions Asked
3689
Tutors
1444874
Questions Answered
Start Excelling in your courses, Ask an Expert and get answers for your homework and assignments!!