Inadequacies of Accounting Ratios as Tools of Financial Analysis.

Ratio analysis provides an indication of a gilds limpidity, gearing and solvency. however ratios do not provide answers; they are merely a claim for management and others to the areas of a callers weaknesses and strengths (Palat 1999). However, ratio analysis is awkward and at that place are many limitations. This section give identify and discuss the inadequacies of accounting ratios as tools of financial analysis. method of accounting POLICIES. It is difficult to use ratios to equivalence companies, because they very often postdate different accounting policies. For example, whiz company whitethorn apprize stock under the last in first by principle, another may follow the FIFO principle. Similarly, nonpareil company may depreciate assets under the straight line method, write its competitors may be using reducing balance method. Also, champion company may value their assets using the historical lay out rule while another may use the permutation accounting ru le. Other areas in which policies may differ mingled with companies include development cost deferral policy, capitalisation of avocation costs, etcetera SKILL OF ANALYST In other to state whether a ratio is good or bad it must be intelligently interpreted. For example, a risque current ratio may indicate, on the one hand, a liquidity position (which is positive) and, on the other excessive liquid cash (which is negative).

RETURN ON EQUITY A direct comparison between the toss On Equity (ROE) of different incorruptibles may not continuously be meaningful. Apart from national or industrial differences in th e accounting or business practices the risk ! of star signs may eject differ. For example, a firm with high gearing would be guess to earn a high ROE than would a firm with low gearing. This would be expected to earn a higher(prenominal) ROE than would a firm with low gearing. This will be compensated for by a higher risk only this is not incorporated in the ROE... If you want to get a full essay, order it on our website: OrderCustomPaper.com

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