Although Ratio Analysis is a very useful accounting tools to analyze and interpret different accounting equations, it comes with its own set of limitations:
● If the data received from financial accounting is incorrect, then the information derived from ratio analysis could not be reliable.
● Unauthenticated data may lead to misinterpretation of ratio analysis.
● Future prediction may not be always dependable, as ratio analysis is based on the past performance.
● To get a conclusive idea about the business, a series of ratios is to be calculated. A single ratio cannot serve the purpose.
● It is not necessary that a ratio can give the real present situation of a business, as the result is based on historical data.
● Trend analysis is done with the help of various calculated ratios that can be distorted due to the changes in the price level.
● Ratio analysis is effective only where same accounting principles and policies are adopted by other concerns too, otherwise inter-company comparison will not exhibit a real picture at all.
● Through ratio analysis, special events cannot be identified. For example, maturity of debentures cannot be identified with ratio analysis.
● For effective ratio analysis, practical experience and knowledge about particular industry is essential. Otherwise, it may prove worthless.
● Ratio analysis is a useful tool only in the hands of an expert.
