Explain the limitations of analysis of financial statements.
Limitations of Analysis of Financial Statements :
Limitations of Financial Statements:
Financial Statements are the basis- for financial analysis. Hence, the limitations of financial statements, such as influence of accounting concepts and conventions, personal judgement, disclosure of only monetary events etc. are also the limitations of analysis of financial statements.
Ignores Price-Level Changes:
Financial analysis is based on financial statements, which are merely a record of historical cost. The analysis of financial statements will not yield comparable results unless the price level changes are taken into account.
Personal ability and bias of analyst:
Influence of personal judgement also affects the analysis and interpretation of financial statement, as it is done by human beings. The financial analysis is also affected by the personal ability and bias of the analyst.
Estimated position and not real position:
Since the financial statements are prepared on a ‘going concern basis as against liquidation basis, they report only the estimated periodic results and not the true results since the true results can be ascertained on the liquidation of the enterprise.
The term window dressing means presentation of accounts that conceals vital facts and showing better position than what it actually is. On account of such a situation, financial analysis may not be a definite indicator of good or bad management.
Limitation in inter-firm analysis:
Social, economic and political conditions in which the various firms are operating may be different and this inter-firm analysis may not be true and useful.