Problems In Using Financial Ratios

Financial ratios do have some limitations that must be considered when we use them in analyzing a company.

First, a single ratio will not give you enough information to make a judgment about the firm. You must have additional data to make these judgments. The source of this data might be from comparing the ratios to the industry average or past company performance.

Second, you should use the same time frame in making any comparison. If you don't use the same time frame effects caused by recessions or seasonal fluctuations could result in erroneous conclusions or judgments.

Third, it is best to use audited financial statements. Audited statements assures you of accurate financial information.

The last problem that one must consider is that the financial information was developed using the same accounting methods.

Financial analysis is not perfect and mistakes can be made. To prevent this from occurring you must realize mind these limitations, in order for financial ratios to be an effective tool for managers.