Limitations of Financial Statement Analysis : Analysis of financial statements helps the interested parties in ascertaining the strengths and weakness of an enterprise, but at the same time it suffers from certain limitations. These limitations must always be kept in mind while undertaking the analysis of financial statements.
The limitations of financial statements analysis are :
(i) Historical Analysis: Financial statement analysis is a historical analysis. It analysis what has happened till date. It does not reflect the future. Person like shareholders, investors etc. are more interested in knowing the likely position in future.
(ii) Ignore Price Level Changes: Price level changes and purchasing power of money are inversely related. A change in the price level makes analysis of financial statements of different accounting years invalid because accounting records ignore change in value of money.
(iii) Qualitative Aspect Ignored: Since the financial statements are confined to monetary matters alone, the qualitative aspects like quality of management, quality of staff, public relations are ignored while carrying out the analysis of financial statements.
(iv) Suffers from the Limitations of Financial Statements : Analysis of financial statements is based on the information given in the financial statements. Hence, this analysis suffers from all such limitations from which the financial statements suffer. Therefore, unless the basic data given in the financial statements is reliable the conclusions derived on the basis of the analysis of this data cannot be reliable.
(v) Not Free from Bias: In many situations the accountant has to make a choice out of alternatives available e.g., choice in the method of inventory valuation or choice in the method of depreciation (straight line or written down value etc.) Since the subjectivity is inherent in personal judgement the financial statements are therefore not free from bias.
(vi) Variation in Accounting Practices: From inter firm comparison it is necessary the accounting practices followed by the firms do not very significantly. As there may be variations in accounting practices followed by different firms a meaningful comparison of their financial statements is not possible.
(vii) Window Dressing: Window dressing refers to the presentation of a better financial position that what it actually is by manipulating the books of account. On account of such a situation financial analysis may give false information to the users.
(viii) Identifies Symptoms : Financial analysis identifies symptoms of the problems but does not | offer its diagnosis. The management has to look for the remedy to rectify the problems.
