RATIONALE AND CONTEMPLATION OF RATIO ANALYSIS
may not be available to the users in order to make an informed judgment. For example, loss in one product may be set off by substantial profits in another product line. But, the overall net profit ratio may be favorable. (d) Impact of Seasonal Factors: When the operations do not follow a uniform pattern during the financial period, ratios may not indicate the correct situation. For example, if the peak supply season of a business is between Februarys to June, it will hold substantial stocks on the balance sheet date. This will lead to a very favorable current ratio on that date. But the position for the rest of the year may be entirely different. (e) Differences in Accounting Policies: Different firms follow different accounting policies, e.g. rate and methods of depreciation. Straight-jacket comparison of ratios may lead to misleading results. (f) Lack of Standards: Even though some norms can be set for ratios, there is no uniformity as to what an “ideal” ratio is. Generally it is said that Current Ratio should be 2:1. But if a firm supplies mainly to Government Departments where debt collection period is high, a Current Ratio of 4:1 or 5:1, may also be considered normal. (g) High or Low: A number by itself cannot be “high” or “low”. Hence, a ratio by itself cannot become “good” or “bad”. The line of difference between “good ratio” and “bad ratio” is very thin. (h) Interdependence: Financial Ratios cannot be considered in isolation. Decision taken on the basis of one ratio may be incorrect when a set of ratios are analyzed.Pages: 1 2 3 [4] 5 6
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19.04.2010
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