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IAI Actuarial Core Principles · Business Finance · Interpreting company accounting information

An analyst wants to reduce the limitations of ratio analysis when assessing a listed Indian manufacturer. Which approach is most appropriate?

The best approach is to analyse trends over several years, compare with similar firms, and use non-financial information and the notes on accounting policies. Context reduces the limitations of ratios, whereas relying on one year or one ratio gives a partial and potentially misleading picture.

  1. ARely on a single year's ratios, since they are precise
  2. BCompare trends over several years and against similar firms, and also consider non-financial information and the notes to the accountsCorrect
  3. CUse only the ratios that show the company favourably
  4. DIgnore accounting policies, as all firms use identical ones
  5. Base the view on one liquidity ratio alone

Explanation

Ratios gain meaning from context: trends over time, comparison with similar firms, awareness of differing accounting policies, and qualitative information. A single ratio or single year gives an incomplete picture, and selective use is biased.

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