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P2 C5 ACCOUNTNG RATIOS AND ANALYSIS — Elements of Account STD 12 Commerce — Question

Gujarat BoardEnglish MediumSTD 12 CommerceElements of AccountP2 C5 ACCOUNTNG RATIOS AND ANALYSIS3 Marks
Question
Describe three limitations of ratio analysis.
✓

Answer

Main three limitations of ratio analysis can be as under :
$1.$ Absence of standard ratios: Any individual ratio does not provide any analysis or interpretation. The use of ratios can be established only when the standard ratios are available for comparison. If standard ratios are not determined, the computed ratios become useless.
$2.$ Influence of price changes: The base for ratio analysis is financial statement. Financial statements are prepared with historical information and in historical information the effect inflation is not considered which is also a limitation.
$3.$ Difficulty in comparison: When two same category, business entities, follow different accounting policies, then information obtained by ratio analysis becomes useless, e.g. method of depreciation, method of stock valuation etc.
$4.$ Limited Utility: The utility of ratios calculated on the basis of only one year is limited For the comparison the figures of the previous year and those of the current year is not much useful. If possible the figures of the firm ought to be compared with those of a firm similar business.
$5.$ Factors Neglected: It is obvious that a business is affected by external and internal factors, competition and total economic condition of the country. But these factors are not included in the calculation of ratios. Since they are calculated on the past figures, they have limited utility.

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