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
Compute the Payback Period - Example Cedes restriction has the following details of two (2) of the future production plans. Just one of these machines will be purchased and su

Terms used in Capital Market Authority 1. ACCOUNTS fourteen (14) days durations into that the stock exchange trading calendar is divided. 2. ACCOUNTS DAY - Sixth or sev

Capital Market Authority (CMA) Was established in 1990 with an Act of Parliament to assist, in creation of a conducive environment, for growth and development of capital marke

Suppose an entrepreneur owns a firm that has a production technology that generates the following revenue: R(e) = e 2 +100e where revenue depends on his effort level e. The monetar

1-Suppose you deposit $ 5 000 in the bank. How much can you raise after 10 years when discount rate is 5% for the first four years and then rises to 7% annually? 2 -A used car co


Instructions 1 This case study counts as part of your group project. 2 Project Group: You must complete this assignment together with the group that you initially registered

Earnings Yield Valuation EY is given via the earnings made with the business expressed like a percentage of the market price of the business that is The Formula For Earning

After read all the available information carefully, prepare a two page (double-spaced) essay and answer the following questions: Assume that we have the following data: C=100+0.50Y

Define benefit plan for the employee participants