Limitations of ratio, Finance Basics

Limitations of Ratio

Ratios have weaknesses as following like:

1. They avoid the size of the firm being compared as in cross-sectional analysis; the firm being compared might be of different product, technology and size diversification.

2. Effect of inflation: Ratio avoids the effect of inflation in performance as increase gradually in sales might be due to increase in selling price caused by inflationary pressure in the economy.

3. Ratios avoid qualitative or non-quantifiable aspects of the firm as important assets that as corporate image, customer loyalty, quality of product, efficient management team, technological innovation etc are not captured in such ratio analysis.

4. Ratios are computed only at single point in time such is they are subject to frequent changes after computation as liquidity ratios will constantly change like the debtors, cash and stock level changes.

5. Monopolistic firms : It is very difficult to carry out industrial and cross-sectional analysis to monopolistic firms while they do not have competitors and they are the just firms in the whole industry

6. Historical Data: Ratios are computed in financial statement or historical information therefore may be irrelevant in future decision-making of

7. Computation and interpretation : Usually some ratios do not have an acceptable standard of computation.  This may differ from one industry to another. Like the return on investment may be computed like as:

Return on investment =  EBIT / Total assets or EAT/ Total assets

8. Different accounting policies : Different firms in the similar industry use many accounting policies as ways of depreciation and stock valuation.  This creates comparison difficult.

Posted Date: 1/30/2013 2:25:36 AM | Location : United States







Related Discussions:- Limitations of ratio, Assignment Help, Ask Question on Limitations of ratio, Get Answer, Expert's Help, Limitations of ratio Discussions

Write discussion on Limitations of ratio
Your posts are moderated
Related Questions
Following the Initial Public Offering (IPO), the shares of Rosetta Stone, the language instruction company, jumped almost 44 percent from an initial price of $18 to $25.55 in late-

Financial Planning A financial manager along with present investment policies will be concerned along with how efficiently the company's funds are invested since it is from t

Advantage of Bill - Source of Finance Advantages of necessitating a Bill as a Source of Finance They are a faster means of raising finance whether drawer is credible.

Differences between Debt and Preference Share Capital Differences between Debt and Preference Share Capital are given below:   DEBT

Define the direct finance and indirect finance in markets. In direct finance, borrower-spenders borrow funds directly by lenders into the financial markets through selling them

Suppose that two players are playing the following game.  Player A can choose either Top or Bottom, and Player B can choose either Left or Right.  The payoffs are given in the foll

I need help with financial econometric questions, i got stuck in finding answers for my homework, Can you provide engineering level financial econometric homework help? I need expe

Current cost of a bond: You know that the after-tax cost of debt capital for Bubbles Champagne is 7 percent. If the firm has only one issue of five-year maturity bonds outstanding,


Turnover Ratios Turnover Ratios/efficiency/asset management ratio Turnover ratio shows the efficiency along with that the firm utilized the asset or resources at its dispos