Ratios from financial statements can be used to analyze and compare different aspects of a firm, which is often easier for an individual than reading through the financial statements themselves. The ratios determine the how effective and efficient the firm is, while the statements themselves only give the raw data about the firm. The analysis of this data is what allows management and owners to see what areas are doing well and what areas are in need of improvement. Ratios from the financial statements allow an individual to see how liquid a firms assets are, how effectively these assets are being utilized in terms of generating profits, how quickly a firm is able to turn over their inventory, how long it takes them to collect on their receivable accounts, and also it allows them to easily see how their different profit numbers relate to their overall sales.
The limitations of industry average ratios include that it can sometimes be difficult to determine which industry a firm belongs to, that the industry averages are only approximations, an industry average is not necessarily a desirable target ratio, accounting practice differ widely among firms, financial ratios can be too high or too low, and many firms experience seasonal change in their operations (Keown,128). In order to combat these limitations, it helps to know more about the firm and the competition that it is in. Looking at the ratios alone only tells a small portion of the story.