Financial Statement Analysis Limitations

Many things can impact the calculation of ratios and make comparisons difficult. The limitations include:
    • The use of estimates in allocating costs to each period. The ratios will be as accurate as the estimates.
    • The cost principle is used to prepare financial statements. Financial data is not adjusted for price changes or inflation/deflation.
    • Companies have a choice of accounting methods (for example, inventory LIFO vs FIFO and depreciation methods). These differences impact ratios and make it difficult to compare companies using different methods.
    • Companies may have different fiscal year ends making comparison difficult if the industry is cyclical.
    • Diversified companies are difficult to classify for comparison purposes.
    • Financial statement analysis does not provide answers to all the users' questions. In fact, it usually generates more questions!
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