Use and Limitations of Financial statement analysis (using RatiOS)
Attention should be given to the following issues when using financial ratiOS:
- A reference point is needed. To to be meaningful, most ratiOS must be compared to historical values of the same firm, the firm's forecasts, or ratiOS of similar firms.
- Most ratiOS by themselves are not highly meaningful. They should be viewed as indicators, with several of them combined to paint a picture of the firm's situation.
- Year-end values may not be representative. Certain account balances that are used to calculate ratiOS may increase or decrease at the end of the accounting period because of seasonal factors. Such changes may distort the value of the ratio. Average values should be used when they are available.
- RatiOS are subject to the limitations of accounting methods. Different accounting choices may result in significantly different ratio values.
