F6 - Limitations of ratios

What can financial data be used for?

• Financial data can be used to identify areas where performance can be improved and the reasons for trends.

• It can therefore help to inform decision making.

• There are strengths in using financial data as well as potential limitations.

What are the strengths of ratios?

• Provides a tool for the interpretation of accounts.

• Structure from which comparisons can be made - overtime, with other businesses/intra comparisons.

• Aids decision making - internally, externally by investors

What are the limitations of ratios?

• Possibility that accounts have been window dressed - falsifying figures to make them look more appealing.

• Need to consider reasons behind ratios - is ROCE lower than previous years because of an investment programme.

• Quantitative information only - qualitative factors such as ethics are not taken into account.

• Different businesses produce their accounts in different ways so they may not be easy to compare.

• Data used may be out of date which means the ratio results may be inaccurate.

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