Limitations of Ratio Analysis Essay.

Posted: December 31st, 2022

Limitations of Ratio Analysis Essay.

What are the benefits of ratio analysis? What are the limitations of ratio analysis? What can be done to minimize the limitations on ratio analysis? Explain. Cite any references used.Limitations of Ratio Analysis Essay.

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AMP 3 DQ 1
Ratio analysis is a tool used to assess and analyze the financial situation of an organization. In fact, it is used to make sense of the financial accounts while gaining a better awareness of the current fiscal situation. The tool is intended to facilitate comparison, determine overall financial strength, ensure suitable liquidity, evaluate operational efficiency, and measure profitability. Using the tool offers four benefits. Firstly, it allows for comparisons to allow the organization better understand its position in relation to the competition and within the industry. Secondly, it helps identify problem areas. Limitations of Ratio Analysis Essay.Thirdly, it simplifies the complex financial data and accounting statements into simple ratios. Finally, it helps in validating the financial decisions that the organization makes. Although ratio analysis offers unique benefits, it has some limitations. Firstly, they do not offer solutions for financial problems. They simply point out the problems that plague the company. This limitation can be addressed through ensuring that the ratio analysis results are used as intended in identifying management problems. Secondly, there are no standard definitions for ratio analysis such that the formulas differ thereby making it difficult to compare results across the industry. This limitation can be addressed through using the same formulas for the ratios. Thirdly, ratio analysis is focused on quantitative aspects while ignoring the qualitative aspects of the organization. This limitation can be addressed through the use of complementation financial analysis tools that evaluate the qualitative aspects.Limitations of Ratio Analysis Essay. Finally, ratio analysis ignores inflation effects on price level. That is because it uses historical records without consideration for changes between periods. This limitation can be addressed through the use of financial analysis tools that consider the effects of inflation(Weygandt, Kimmel&Kieso, 2015).Limitations of Ratio Analysis Essay.