Limitations of ratio analysis
Ratios depend on definitions, measurement policies, period-end balances and the quality of underlying data. Inflation, seasonality, acquisitions, non-recurring items and different accounting treatments can affect trends and peer comparisons. A ratio identifies a question rather than proving a cause; use cash flow, explanatory notes and non-financial information alongside it. Define the numerator and denominator before drawing conclusions.
Worked example
A retailer’s current ratio is calculated at year end immediately after it sells seasonal inventory. The ratio may be stronger than during the rest of the year, so the analyst reviews monthly balances and cash flows before concluding liquidity is consistently strong.
Common mistake
Assuming a year-end ratio describes the average position throughout the year or comparing differently defined measures without adjustment.
Where it appears in your exams
| Qualification | Exam | Relationship | Period |
|---|---|---|---|
| ACCA | FR | Direct | September 2026–June 2027 |
| ACCA | SBR | Direct | September 2026–June 2027 |