Limitations of Analysis based on Financial Statements

Limitations of Analysis based on Financial Statements

Traditional analysis has certain weaknesses.

The analysis is based on financial statements prepared and presented by the company.

• These statements provide information of the recent past, which may not be very relevant.
• The financial statements could also have been subjected to 'creative accounting'. For example, a revolving loan, which is renewed every three months, may be shown as a current liability when in fact it could be a long-term loan in substance.

Different companies will use different accounting policies.

• Therefore a comparison between companies may not be completely reliable.
• To make useful inter-firm comparisons the companies selected have to be in the same industry, be similar in size, face similar challenges, etc. It may be near impossible to get a company similar to the one being studied.