19.3 Limitations of Ratios Analysis
　　Ratio analysis is useful for providing valuable insights into the financial position and performance of the company. There are however, several limitations:
　　1. When financial analysis is done for forecasting purposes bear in mind that past performances may not continue in the future as a result of inevitable changes.
　　2. Failure to adjust for inflation or changes in fair values may cause some ratios to provide mis-leading information.
　　3. Comparative information may not always be available.
　　4. Ratios by themselves are useless. They should never be considered in isolation.
　　5. Beware of using obsolete information.
　　6. Companies may use different accounting policies and procedures and this may hinder comparison.
　　7. What is appropriate standard for one business enterprise may not be appropriate for another because of the many factors that cause one business to be very different from another. It should be recognized that if some ratios are ‘too favorable’, this may indicate lost opportunities. A business with excessive short-term liquidity may be failing to take advantage of all its business opportunities.
　　8. To arbitrarily select the last day of that period as the basis for the preparation of a statement of financial position can only result in bias. The station nature of a statement of financial position creates opportunities for “window dressing”, which may add more bias to the information presented.
　　9. Non-financial information may be just as important and helps in obtaining a completed picture of the state of the organization. It includes, for example, the number of employees in the organization and the types of skills they possess or indicators of efficiency with which the organization addresses complaints from customers.
　　Example 1:
　　Which one of the following would help a company with high gearing to reduce its gearing ratio?
　　A. Making a rights issue of equity shares
　　B. Issuing further long-term loan notes
　　C. Making a bonus issue of shares
　　D. Paying dividends on its equity shares
　　Solution A
　　Example 2:
　　Which one of the transaction would result in an increase in capital employed?
　　A. Selling inventory at a profit
　　B. Writing off a bad debt
　　C. Paying a payable in cash
　　D. Increasing the bank overdraft to purchase a non-current asset
　　Solution: A
　　Profit will addition to the company’s capital
　　Example 3:
　　An increase in selling prices may lead to which of the following effect?
　　A. Asset turnover will increase
　　B. Profit margins will fall
　　C. Profit margins may increase subject to a fall in asset turnover
　　D. Return on capital employed will increase
　　Solution C
　　A- Increased prices may result in reduced sales so asset turnover may fall.
　　B- Selling price increases should increase margin.
　　D- The effect of a price increase will be increased margins but reduced asset turnover, therefore
　　effects on return on capital may be nil.