Question

What are the limitations of financial ratio analysis? Give examples

Answer 1

Limitations of financial ratios

1. Cannot be calculated effectively if the numerator or the denominator have different signs

2. Denominator can be zero, hence rendering the ratio meaningless

3. May not always capture the changing strategy of the organization. And hence, an analyst could miss important changes in the organisation design.

4. Cannot be used as a standalone figure. It must be compared with ratios from previous periods or from other organizations.

5. Cannot help with better understanding during extraordinary periods (say, a period of very high or low growth)