Limitations Of Financial Ratios

To fully understand a firm’s strengths and weaknesses, you should use on of the two standards against which ratios can be compared.
1. Similar ratios can be computed for the same firm from its previous financial statement. This is commonly referred to as trend analysis and requires that the analyst look at each ratio over several statement periods.
2. A second type of standard for comparison comes from ratios generated from firms that have characteristics similar to the subject firm. These are referred to as industry average ratios.
Even after comparison with the peers in the same industry, its competitors and its past trends, you would find that the ratios do not provide the full picture of the company’s performance over any period of time. Always remember the ratios are just the indicators of the company’s performance and their analysis is not perfect in giving you the final verdict.