Financial Ratio Analysis Disadvantages

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Financial Ratio Analysis - Definition, Purpose, Advantages, and Disadvantages
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Financial Ratio Analysis - Definition, Purpose, Advantages, and Disadvantages
Meaning of Financial Ratios: Financial Ratios are essential quantitative financial tools that are comprehensively used by financial experts to analyze a company’s financial performance such as business evaluation, fundamental analysis, business analysis, etc. In financial ratio analysis, an expert uses ratio to study various financial parameters from a company’s financial statements such as income statement, balance sheet etc., for efficient and effect decision making.
Some of the financial ratios are listed below for
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Investment Bankers use ratios as a very important tool in assisting clients in the buy/sell side advisory.
• Companies in identifying gaps in the operation or departments and devising corrective steps to fill the gaps also use identifying Gaps and Finding Solutions- Ratios.
Limitation of Ratios
• Effect of external business environment – Sometimes external factors such as inflation etc. can have effect on the company’s performance and the use of ratios can be limited in such scenarios.
• Diversified Products/Industries- It is difficult to use ratios to evaluate big companies that work across different industries or location as it is difficult to find a common ratio/parameter to perform such analysis.
• Dependencies on Accounting Figures- Ratios depend heavily on accounting figures, which are themselves subject to a lot of approximations, diversities, assumptions, and manipulations.
• Interpretation- Ratios are subject to interpretation and can be impacted by some events that have taken place in the company. For example, a spin off may change the current ratio but it may not necessary reflect the operating performance of a
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