Ratio Analysis Disadvantages

2) Common size financial statement analysis:

The common size statements (i.e. balance sheet & income statement) are shown in analytical percentages. The figures of these statements are shown as percentage of total assets, total liabilities & total sales respectively.

Take the example of balance sheet, the total assets are taken as 100 & different assets are expressed as a percentage of the total. Similarly, various liabilities are taken as a part of total liabilities.

(a) Common size balance sheet:

A statement where balance sheet items are expressed in the ratio of each asset to total assets & the ratio of each liability is expressed in the ratio of total liabilities is called as common size balance sheet.

Thus the common size financial statement should be prepared in the following way:

• The total assets or liabilities are taken as 100.

• The individual

or Ratio Analysis means one number expressed in terms of another number. It shows relationship of one figure with another figures is called as ratio analysis.

For example: Current ratios.

Since ratios are future-oriented, the analyst must be able to adjust the factors present in a relationship to their probable shape and size in future. Thus, in the final analysis, the usefulness of ratio is wholly dependent on their intelligent and skilful interpretation.

Advantages or Uses of ratio analysis:

1) It helps in budgetary control.

2) It facilitates the inter-firm and intra-firm comparison.

3) It helps in standard costing.

4) It is helpful to the management for decision making.

5) It helps in determining overall development of the firm.

6) It serves as an effective means of communication.

7) It helps in auditing.

Dis-advantages or Limitations of ratio analysis:

1) It is based on historical data.

2) There is no clear formula for calculating ratios.

3) Ratios are tools of quantitative analysis