Inadequacies of Accounting Ratios as Tools of Financial Analysis.

Ratio analysis provides an indication of a company's liquidity, gearing and solvency. But ratios do not provide answers; they are merely a guide for management and others to the areas of a company's weaknesses and strengths (Palat 1999). However, ratio analysis is difficult and there are many limitations. This section will identify and discuss the inadequacies of accounting ratios as tools of financial analysis. ACCOUNTING POLICIES. It is difficult to use ratios to compare companies, because …

…through by a negative. Thus a loss of £10 m on a firm with a negative equity of £10 m will appear to be earning a return on equity of 100 percent. Equally difficult are the extreme ratio values that are calculated when dividing by a very small number. For example, earnings growth is problematic because earnings is an erratic variable and may in any one year be unusually small or negative.