ArtsAutosBooksBusinessEducationEntertainmentFamilyFashionFoodGamesGenderHealthHolidaysHomeHubPagesPersonal FinancePetsPoliticsReligionSportsTechnologyTravel

LIMITATIONS OF RATIOS | DISADVANTAGES OF USING RATIOS IN MAKING INVESTMENT DECISIONS

Updated on January 19, 2013

Ratio analysis is a scientific attempt devised by intelligent humans to reasonably predict the future outcome of investment. As true as this may be, investors still need to use ratio analysis with caution. Other fundamental factors should be allowed to play its role in the development of investments strategy and subsequently following it. Investors over the year have come to appreciate the importance good ratio analysis as part of their investment appraisal tools

In this article are some of the already identified limitations of ratios analysis.

DISADVANTAGES OF RATIOS

PROBLEM IN GETTING COMPARABLE INFORMATION

It is a known fact that ratios are useless if they are not compared with ratios from similar entity. You must compare likes to have realistic information. In practice, it is impossible to consciously find two companies that are identical in every sense.

USE OF OUTDATED INFORMATION

Historical accounting information is the primary source of data used for investment ratio analysis. This alone is enough to render every other factor useless. It is hard to make any meaningful judgment from information that is already out of date.

RATIOS ARE SUBJECTIVE

No two humans will give two exact judgments even while presented with the same information. Personal sense of judgment must be introduced and this makes it prone to having personal investment bias.

ANALYSIS CANNOT BE USED IN ISOLATION

Yes, an investment ratio analysis cannot be used in isolation. It must be combined with some other information from other sources. This makes it possible for element of wrong judgment to be introduced into the decision making variables through the introduction of information from unreliable and unverifiable source.

RATIOS ARE NOT DEFINITE

Ratio analyses are just guide and never a definite or concrete assertion. This makes it possible for wrong investment decision to be taken. Investment ratio analysis is not like mathematics and is therefore susceptible to inflows of noise.

RATIOS ARE SUBJECT TO MANIPULATION (CREATIVE ACCOUNTING, INAPPROPRIATE ACCOUNTING POLICIES)

Creative accounting and other form of manipulations like window dressing of accounts is a serious factor that affects financial statements ratio analysis. An investment analyst working on ratio analysis should bear this at the back of his or her mind.

RATIOS HAVE NO STANDARD FORM

There are no generally acceptable formats for presenting and interpreting ratios. This is in addition to the fact that ratio analyses are subjective in nature.

All the above points show that ratio analysis cannot be used in isolation and should be used with wisdom and caveat. Investing is not a pure science and like every other management science discipline deals with a lot of behavioural factors and unstable variables

Analyse carefully and wisely!

Comments

    0 of 8192 characters used
    Post Comment

    • profile image

      kneencediah 

      5 years ago

      My spouse and i helpful to find at the top of living however these days I have developed a new opposition.

    • profile image

      mpue! 

      6 years ago

      it brings much greater light about the limitations and how they actually affect decision making

    working

    This website uses cookies

    As a user in the EEA, your approval is needed on a few things. To provide a better website experience, hubpages.com uses cookies (and other similar technologies) and may collect, process, and share personal data. Please choose which areas of our service you consent to our doing so.

    For more information on managing or withdrawing consents and how we handle data, visit our Privacy Policy at: https://hubpages.com/privacy-policy#gdpr

    Show Details
    Necessary
    HubPages Device IDThis is used to identify particular browsers or devices when the access the service, and is used for security reasons.
    LoginThis is necessary to sign in to the HubPages Service.
    Google RecaptchaThis is used to prevent bots and spam. (Privacy Policy)
    AkismetThis is used to detect comment spam. (Privacy Policy)
    HubPages Google AnalyticsThis is used to provide data on traffic to our website, all personally identifyable data is anonymized. (Privacy Policy)
    HubPages Traffic PixelThis is used to collect data on traffic to articles and other pages on our site. Unless you are signed in to a HubPages account, all personally identifiable information is anonymized.
    Amazon Web ServicesThis is a cloud services platform that we used to host our service. (Privacy Policy)
    CloudflareThis is a cloud CDN service that we use to efficiently deliver files required for our service to operate such as javascript, cascading style sheets, images, and videos. (Privacy Policy)
    Google Hosted LibrariesJavascript software libraries such as jQuery are loaded at endpoints on the googleapis.com or gstatic.com domains, for performance and efficiency reasons. (Privacy Policy)
    Features
    Google Custom SearchThis is feature allows you to search the site. (Privacy Policy)
    Google MapsSome articles have Google Maps embedded in them. (Privacy Policy)
    Google ChartsThis is used to display charts and graphs on articles and the author center. (Privacy Policy)
    Google AdSense Host APIThis service allows you to sign up for or associate a Google AdSense account with HubPages, so that you can earn money from ads on your articles. No data is shared unless you engage with this feature. (Privacy Policy)
    Google YouTubeSome articles have YouTube videos embedded in them. (Privacy Policy)
    VimeoSome articles have Vimeo videos embedded in them. (Privacy Policy)
    PaypalThis is used for a registered author who enrolls in the HubPages Earnings program and requests to be paid via PayPal. No data is shared with Paypal unless you engage with this feature. (Privacy Policy)
    Facebook LoginYou can use this to streamline signing up for, or signing in to your Hubpages account. No data is shared with Facebook unless you engage with this feature. (Privacy Policy)
    MavenThis supports the Maven widget and search functionality. (Privacy Policy)
    Marketing
    Google AdSenseThis is an ad network. (Privacy Policy)
    Google DoubleClickGoogle provides ad serving technology and runs an ad network. (Privacy Policy)
    Index ExchangeThis is an ad network. (Privacy Policy)
    SovrnThis is an ad network. (Privacy Policy)
    Facebook AdsThis is an ad network. (Privacy Policy)
    Amazon Unified Ad MarketplaceThis is an ad network. (Privacy Policy)
    AppNexusThis is an ad network. (Privacy Policy)
    OpenxThis is an ad network. (Privacy Policy)
    Rubicon ProjectThis is an ad network. (Privacy Policy)
    TripleLiftThis is an ad network. (Privacy Policy)
    Say MediaWe partner with Say Media to deliver ad campaigns on our sites. (Privacy Policy)
    Remarketing PixelsWe may use remarketing pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to advertise the HubPages Service to people that have visited our sites.
    Conversion Tracking PixelsWe may use conversion tracking pixels from advertising networks such as Google AdWords, Bing Ads, and Facebook in order to identify when an advertisement has successfully resulted in the desired action, such as signing up for the HubPages Service or publishing an article on the HubPages Service.
    Statistics
    Author Google AnalyticsThis is used to provide traffic data and reports to the authors of articles on the HubPages Service. (Privacy Policy)
    ComscoreComScore is a media measurement and analytics company providing marketing data and analytics to enterprises, media and advertising agencies, and publishers. Non-consent will result in ComScore only processing obfuscated personal data. (Privacy Policy)
    Amazon Tracking PixelSome articles display amazon products as part of the Amazon Affiliate program, this pixel provides traffic statistics for those products (Privacy Policy)