ACCA Applied Knowledge · Financial Accounting · Analysis of financial statements
Which of the following is a limitation of using ratio analysis to compare two companies' performance?
A key limitation is that companies may adopt different accounting policies, such as depreciation methods, so reported profits and asset values differ and ratios are not directly comparable. Ratios are not limited to cash flow data, and they do not adjust for inflation.
- AThe companies may use different accounting policies, such as depreciation methods, which make the ratios not directly comparableCorrect
- BRatios can only be calculated from the statement of cash flows
- CRatios are calculated from audited information and so cannot be used for comparison
- DRatios always remove the effect of inflation from the results
Explanation
Different accounting policies, for example straight-line versus reducing balance depreciation or differing inventory valuation methods, affect reported profit and asset values, so ratios between companies may not be like-for-like. Ratios are mostly drawn from the statement of financial position and statement of profit or loss, and they do not remove inflation effects.
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