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Accounting Ratios have been used by a number of companies as indicators of their financial performance in the present and even in the future. Discuss...

      

Accounting Ratios have been used by a number of companies as indicators of their financial performance in the present and even in the future. Discuss the five limitations associated with their use for this purpose.

  

Answers


Mutiso
The limitation of Financial Ratios
i) Historical
Ratios computed are usually computed using historical information. As
such they cannot be used to forecast on what will happen in the future as
they are usually used.
ii) Non qualitative
Ratios cannot be calculated for qualitative aspects e.g. the performance of a
company in the social responsibility front or even the competency of a
manager at his work. As such they are limited to the things they can discuss
about a business.
iii) Monopolies
One of the uses of financial ratios is so that they can be compared with
other firms in the industry that a firm is operating in. This however is not
possible for companies which are monopolies since there are no firms to
compare with e.g. KENGEN the electricity provider in Kenya
iv) Different Accounting Policies
Different firms use different accounting policies e.g. in depreciation
costing their closing stock etc.,
This may be a hindrance in comparing the accounting policies of different
companies as the ratios may be differently computed.
v) Companies falling under different Industries
These companies are hard to classify for purposes of ratio analysis in that
it's not possible to know under which industry to place them for
comparison purposes.
An example would be Unilever Kenya who deal with very many goods and
as such it may be hard to put them into a certain industry.
Mutiso answered the question on November 24, 2018 at 17:55


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