Explain how inflation limits financial statement analysisSol

Explain how inflation limits financial statement analysis.

Solution

Inflation affects financial statement analysis in the following ways and hampers time series comparision:

Both of the above reasons lead to misrepresentation of financial ratios such as net profit margin, activity ratios, fixed asset turnover ratio etc. which would make comparison between financial statements of various years nonsensical. Also if we analyse a single year\'s performance, that will not be correct as well.