Limitations of Financial Statement Analysis:
Although financial statement analysis is highly useful tool, it has two limitations. These two limitations involve the comparability offinancial data between companies and the need to look beyond ratios.
Comparison of Financial Data:
Comparison of one company with another can provide valuable clues about the financial health ofan organization. Unfortunately, differences in accounting methods between companies sometimes make it difficult to compare the companies' financial data. For example if one firm values itsinventories by LIFO method and another firm by the average cost method, then direct comparison of financial data such as inventory valuations and cost of goods sold between the two firms may be misleading.Sometimes enough data are presented in foot notes to the financial statements to restate data to a comparable basis. Otherwise, the analyst should keep in mind the lack of comparability of the data beforedrawing any definite conclusion. Nevertheless, even with this limitation in mind, comparisons of key ratios with other companies and with industry average often suggest avenues for furtherinvestigation.
The Need to Look Beyond Ratios:
An inexperienced analyst may assume that ratios are sufficient in themselves as a basis for judgment about the future. Nothing could be further from thetruth. Conclusions based on ratios analysis must be regarded as tentative. Ratios should not be viewed as an end, but rather they should be viewed as starting point, as indicators of what to pursue ingreater depth. they raise many questions, but they rarely answer any question by themselves.
In addition to ratios, other sources of data should be analyzed in order to make judgment about the futureof an organization. The analyst should look, for example, at industry trends, technological changes, changes in consumer tastes, changes in broad economic factors, and changes within the firm...