Conceptual Diversity

Yet another factor which influences the usefulness of ratios is that there is difference of opinion regarding the various concepts used to compute the ratios. There is always room for diversity of opinion as to what constitutes shareholders equity, debt, assets, profit and so on. Different firms may use these terms in different senses or the same firm may use them to mean different things at different times.

Reliance on a single ratio for a particular purpose may not be a conclusive indicator. For instance, the current ratio alone is not a adequate measure of short-term financial strength; it should be supplemented by the acid-test ratio, debtors turnover ratio and inventory turnover ratio to have a real insight into the liquidity aspect.

Finally, ratios are only a postmortem analysis or what has happened between two balance sheet dates for one thing the position in the interim period is not revealed by ratio analysis. Moreover, they give no clue about the future.

In brief, ratio analysis suffers from some serious limitations. The analyst should not be carried away by its oversimplified nature, easy computation with a high degree of precision. The reliability and significance attached to ratios will largely depend upon the quality of data on which they are based. They are as good as the data itself. Nevertheless, they are an important tool of financial analysis.

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