Explain the weaknesses of ratio analysis Your response shoul

Explain the weaknesses of ratio analysis. Your response should be at least 250 words in length.

Solution

Many large companies operate different businesses in different industries. For these companies it is difficult to find a meaningful set of industry-average ratios. Inflation may have badly distorted a company\'s balance sheet. In this case, profits will also be affected. Thus a ratio analysis of one company over time or a comparative analysis of companies of different ages must be interpreted with judgment. Seasonal factors can also have an impact on ratio analysis. For eg, a retailer\'s inventory may be high in the summer in preparation for the back-to-school season. As a result, the company\'s accounts payable will be high and its ROA low. Different accounting practices can make comparisons difficult even within the same company It is difficult to generalize whether a ratio is good or no. A high quick ratio or a high cash ratio in a historically growth company may be a good sign, but could also be seen as a sign that the company is no longer a growth company and should command lower valuations. The information on the income statement is stated in current costs while some items on the balance sheet are stated at historical cost. This disparity can result in unusual ratio results.