Inadequacies of Accounting Ratios as Tools of Financial Analysis.

Ratio analysis provides an indication of a gilds limpidity, gearing and solvency. besides ratios do not provide answers; they are merely a claim for management and others to the areas of a callers weaknesses and strengths (Palat 1999). However, ratio analysis is operose and at that place are many limitations. This section testament identify and discuss the inadequacies of accounting ratios as tools of financial analysis. explanation POLICIES. It is difficult to use ratios to equivalence companies, because they very often catch different accounting policies. For example, whiz company may cling to stock under the last in first bulge out principle, another may follow the FIFO principle. Similarly, nonpareil company may depreciate assets under the straight line method, piece of music its competitors may be using reducing balance method. Also, mavin company may value their assets using the historical plant rule while another may use the replenishment accounting r ule. Other areas in which policies may differ mingled with companies take on development cost deferral policy, capitalisation of avocation costs, etcetera SKILL OF ANALYST In other to state whether a ratio is good or bad it must be intelligently interpreted. For example, a risque current ratio may indicate, on the one hand, a liquidity position (which is positive) and, on the other excessive liquid cash (which is negative).

RETURN ON EQUITY A direct comparison between the abide On Equity (ROE) of different incorruptibles may not always be meaningful. Apart from national or industrial differences in the accounting or business practices the risk of loyals may muster up differ. For example, a firm with high gearing would ! be prise to earn a high ROE than would a firm with low gearing. This would be expected to earn a high ROE than would a firm with low gearing. This will be compensated for by a higher risk merely this is not incorporated in the ROE... If you want to get a full essay, order it on our website: OrderEssay.net

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