Limitations Of Financial Ratio Analysis

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Accounting analysis techniques used in this research report are
1. Trend analysis focusing on the operating income and net profit
2. Ratio analysis on profitability, liquidity, solvency and efficiency and comparison of ratios with industry competitors.
Trend Analysis: Trend analysis is used to reveal the trend of items for a certain period and is used in combination with ratio analysis to spot a particular trend, explore the causes for the trend and make necessary preparation for future projections (Vishal and Anchal, 2015).
Ratio Analysis: Ratio analysis is the technique of calculating a number of accounting ratios from the figures found in the financial statements, and then compare the ratios with those of previous years or similar activities,
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It is the principle measure of the company’s dividend payout policy(Bob Ryan, 2004).
Dividend payout ratio= Dividend declared during the year / Distributable Earnings
Limitations of financial ratio analysis:
Ratio analysis is the most common techniques used to judge the company’s financial performance. However, there are several limitations:
1. Meaningful ratio analysis needs comparative information. Ratios are meaningless by themselves and only usefulness when they are studied with other ratios (ACCA Global, 2007).
2. Effectiveness of ratio analysis depends on the quality of the financial information .If the accounts are poorly constructed (eg poor estimates of depreciation, bad debts etc) then conclusions drawn from the accounting ratios will be distorted(ACCA Global, 2007).
3. Accounting ratios are based on past financial figures. Financial analysis base on accounting ratios will give misleading result if the effects of inflation, differing bases for valuing assets, or specific price changes not take into account(Barthwai, 2004).
4. Different financial reporting standards and definition and measurement of certain accounting terms are limiting factors which make the ratio analysis crude(Barthwai,
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(Figure 2.4.2, PEST analysis, Source:, Adapted by Research, 2017)
PEST represents for Political, Economic, Social and Technological. This analysis is used to assess these four external factors in relation to the business situation. A PEST analysis helps the management determine how these factors will affect the business performance and activities in the long-term (George and Kamel, 2015).
Limitations of PEST Analysis
1. The external factors considered in PEST analysis are dynamic and complex, which causes difficulties for organizations to predict how and why these factors will influence the business at present or future (Thompson, 2001).
2. PEST analysis not only time consuming but costly because most of the information used in the analysis is collected from external agencies, it is not easy to collect abundant relevant data from right source(Sidharth Thakur,2010).
3. Since PEST analysis checks only the external environment while totally ignoring the internal environment, it is insufficient for business strategic planning for the firm(Sidharth Thakur,
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