Ratio Analysis Limitations

Question 1

Differing policies

Answer 1

Different accounting policies may result in misleading comparisons

Question 2

Historical cost

Answer 2

Historical cost data distorts comparisons

Question 3

Performance criteria

Answer 3

Performance criteria/yardsticks are not appropriate for all industry types

Question 4

Ratio comparisons must consider…

Answer 4

Ratio comparisons must consider:
Current economic climate
Type of industry 
Company’s specific circumstances-
(inc management policy)

Question 5

Single ratio problem

Answer 5

A single ratio provides limited information, but a group of ratios can provide a more detailed picture

Question 6

Matching process

Answer 6

Leads to judgement in an allocation of revenues and expenses to an accounting period

Question 7

Use of historic or fair value

Answer 7

Historical cost may overstate profits in periods of rising prices, fair value may be highly subjective

Question 8

Future doubts - assets

Answer 8

Doubts about an assets future potential (and therefore value), especially long term assets

Question 9

Future doubts - liabilities

Answer 9

Doubts about future level of liabilities, especially long term liabilities subject to uncertainty