Question

Which of the following statements represent a weakness or limitation of ratio analysis? Check all that apply.

a) Ratios provide a historical perspective.
b) Ratios may be industry-specific.
c) Ratios ignore inflation effects.
d) Ratios may be based on estimates.

Answer 1

Ratio analysis has limitations including providing a historical perspective, being industry-specific, ignoring inflation effects, and being based on estimates. All of the choices are correct.

Step-by-step explanation:

Ratio analysis is a tool which helps in evaluating a company's financial performance over a stipulated period of time. However, it also has some limitations:

• Ratios provide a historical perspective: Ratios are based on past financial statements, which may not accurately reflect the current or future performance of the company.
• Ratios may be industry-specific: Different industries have different norms and benchmarks, so ratios may not be directly comparable across industries.
• Ratios ignore inflation effects: Ratios do not take into account the impact of inflation on financial data, which can distort the true financial position of a company.
• Ratios may be based on estimates: Financial statements often include estimates and assumptions, which can affect the accuracy of the ratios calculated.

Hence, all the given options are correct.