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What are importance and limitations of financial ratios?
Importance of financial ratios is as follows −
By analysing and inspecting the previous results, ratio analysis can relate between different items.
Ratio analysis can be used to prepare budget, can formulate policies and also used to plan future.
Ratio analysis tells whether the firm is improving or not.
Ratio analysis act as surveyor of efficiency.
Inter firm comparison can be made.
Tells about short term liquidity position.
Long term solvency can be measured.
With the help of ratio analysis, investors can analyse company’s financial statements to their interest.
Determines profitability of a company.
Operational efficiency can be analysed.
Helps in understanding the business and financial risks of a company.
Advantages of ratio analysis are as follows
By comparing to its competitors, ratio analysis tells about area of improvements by formulating its strategies.
Ratio analysis will check on excessive debt accumulation of a company.
It helps companies to define its limit.
By using ratio analysis companies can check on its internal and externals by calculating required terms.
Disadvantages of ratio analysis are as follows
- Comparison is very difficult.
- It is not a standard method to calculate.
- It can be manipulated by accounting practices.
Limitations of ratio analysis are mentioned below
- Results are compared between companies from similar industries.
- It ignores price change due to inflation.
- It ignores qualitative aspects.
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