What are the Limitations of Financial Analysis?
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What are the Limitations of Financial Analysis?
27, Jan, 2023 0 Comments
What are the Limitations of Financial Analysis?
What are the Limitations of Financial Analysis?
What are the Limitations of Financial Analysis?

What are the Limitations of Financial Analysis?

Limitations of Financial Analysis

Inspite of all significance of analysis of financial statements as discussed above, it has the following limitations:

1. Suffering from the Limitations of Financial Statements: Financial statement suffer from a variety of weaknesses. Balance sheet is prepared on historical record of the value of assets. It is just possible that assets shown in balance sheet may not have the same value Financial statements are prepared according to certain conventions at a point of time, whereas the investor is concerned with the present and future of the company. Certain assets and liabilities are not disclosed by balance sheet. Personal judgement plays an important role in determining the figure of the balance sheet. In other words, we can say that balance sheet cannot be said to have a complete accuracy. Financial statements suffer from these weaknesses, so analysis based upon these statements cannot be said to be always reliable.

2. Absence of Standard Universally Accepted Terminology: Financial accounting is not an exact science. It does not have standard, universally accepted terminology. Different meanings are given to a particular term. There are different methods for charging depreciation. Interest may be charged on different rates. In this way, there is sufficient possibility of manipulation and the financial statements have to suffer. As a result financial analysis also proves to be defective.

3. Ignoring Price-level Changes: The results shown by financial statements may be misleading, if price-level changes have not been accounted for. The ratio may improve with the increase in price, the actual efficiency may not improve. Ratios of the two years will not be meaningful for comparison, if the prices of commodities are different. Changes in price affect cost of production, sales and value of assets as a consequence comparability of ratios also suffers.

4. Ignoring Qualitative Aspect : Financial analysis does not measure the qualitative aspect of the business. It does not show the skill, technical know-how and the efficiency of its employees and managers. It has the quantitative measurement of the performance. It means analysis of financial statements measures only one sided performance of the business. It completely ignores human source. Thus, results served by analysis of financial statements can never be up-to-the mark.

5. Misleading Results in the Absence of Absolute Data : Results shown by financial analysis may be misleading in the absence of absolute data. We cannot have the idea of the size the business. Increase in sales from Rs. 40,000 to Rs. 780,000 shows that sales has doubled. In case of other firm increase of sales from Rs. 1,00,000 to Rs. 2,00,000 also shows that the sales has doubled but the size of the firm is quite different.. Profitability ratio of two firms may be the same, but magnitude of their business may be quite different.

6. Financial Analysis is only a tool, not the final Remedy : Analysis of financial statement is a tool to measure the profitability, efficiency and financial soundness of the business. It should be noted that personal judgement of the analyst are more important in financial analysis. We should not rely on single ratio. Before reaching any conclusion, we should calculate several ratios. Accountant should not be biased in the calculation of ratios. It should not be calculated to prove the personal contention.

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