Limitations of Ratio Analysis for Cross-Sectional Comparisons Essay

balance analysis is a useful technique for comparing a companys instruction execution and position with other companies. However, such comparisons whitethorn be misleading. Some of the limitations of symmetry analysis for cross-sectional comparisons are discussed below Accounting policies Accounting laws let companies to choose score policies and use discretion while preparing accounts. Such a freedom leads to differences in the accounts of companies, which in turn distorts cross-sectional company comparisons. diachronic cost If companies are of different ages, their financial biddings will include non-current assets purchased at different times in the past which will usually be recorded at historic cost.This will mean the different companies give birth different book values of asset, thereby affecting their financial statements tied(p) if the businesses are otherwise identical (Ireland and Leiwy, 2011). Creative accounting Companies tend to gift inflated revenues and redu ced liabilities on the financial statements. In particular, they tend to window dress during earnings results seasons.These tricks make investors believe that companies prepare a fuddled financial position. However, such creative accounting misleads analysts using financial accounting and symmetrys for cross-sectional comparisons. Different risk profiles Companies have different financial and foodstuff risk profiles. Companies in the same patience may face different financial and market risks. For example, a company with a low debt balance may indicate improved financial position. However, banks may not have provided loans to the company owing to the companys low creditworthiness or mettlesome financial risk profiling.Another company in the same industry may have a low financial risk profiling, and it may obtain loans at a reduced rate for expansions. But, the financial statement will only show a high gearing rate. In this case, ratio analysis leads to incorrect interpretati ons and conclusions about both the companies. Qualitative factors Ratio analysis does not consider qualitative factors such as prudence quality, quality of assets, social responsibilities, goodwill etc.Despite the limitations discussed above, financial ratio analysis is still useful in assessing a companys financial performance. Ratios can provide a functional understanding of a companys operations if used intelligently. Analysts need to understand the limitations in the analytical method andmake the necessary modifications.