What are the disadvantages of ratio analysis, Managerial Accounting

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Disadvantages of ratio analysis

1) False results: ratios are based upon the financial statement. In case financial ratio is incorrect or the data upon which ratios are based is incorrect ratio calculated will also be false and defective.

2) Limited use of single ratio: a single ratio usually dose not convey much of a sense. To make a better interpretation a number of ratios have to be calculated which is likely to confuse the analyst then help him in making any meaningful conclusion.

3) Absences of standard universally accepted terminology: different meanings are given to particular term such as some firm take profit before interest and after tax others may take profit before interest and tax. This ratio can be comparable only when both the firm adopt uniform terminology.

4) Ignoring prices level changes: the comparability of ratios suffers if the prices of the commodities in two different year are not the same change in price affects the cost of production sales &also the value of assets. It means that will not be meaningful for comparison if the price of commodities is different.

5) Misleading result in absolute data: in the absence of actual data the size of the business cannot be known if gross profit ratio of two firm is 25% it may be just possible that the gross profit of one is Rs 2500 sales rs 10000. Whereas the gross profit sales 5, 00,000& 20, 00,000 profitability of two firm id same but the meningitides of their business is quite different.

6) Ignoring qualitative factors: ratio analysis is the quantitative measurement of the performance of the business; it ignores the qualitative aspect of the performance of the business. It ignore the qualitative aspect of the firm. It shows that ratio is only one sided to measure the efficiency of business.

7) Window dressing: financial statement can easily be window dressed to present a better picture of it financial and profitability position to outsiders. Hence one has to be very careful in making secession from ratios calculated from such financial statements. But it may be very difficult for an outsider to know about the window dressing made by a firm.

8) Personal bias: ratios are only means of financial analytical and an end in itself. Ratios have to be interpreted and different people may interpret the same ratio in different ways.

9) Incomparable: not only industries vary in their nature but also the firms of the same business widely differ in their size and accounting procedures etc. it make comparison of ratios difficult and misleading. Moreover comparisons are made difficult due to differences in definition of various financial terms used in the ratio analysis.

10) No substitutes of ratios: ratio analysis is merely a tool of financial statement. Hence ratio become useless if separated from the statement from which they are computed.

 

 


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