What are the limitations of financial statement analysis?
– 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!
