An unaware analyst may think the second company to be better but in reality its low encouraging level is due to the fact that it is unable to secure additional funding. The companies may possess different capital structures and to attempt comparison of performance when one is all equity financed and another is a geared company may not suffice for a good analysis. The chosen application of government incentives to several companies may also twist the inter-company evaluation. There may be the possibility of providing a company with the tax holiday while the other within the same line of business not, and evaluation of such two enterprises may be misleading. (Session 15: Limitation of Ratio Analysis) As a matter of principle, the accounting strategies are required to be applied persistently. Changes are required to be emphasized and the influence of variations from an original policy revealed. This is applicable when calculating and interpreting ratios. The progress in the performance of the company cannot be found out if the published accounting figures are manipulated so as to generate favorable results. However, the benchmark comparisons against other companies in a sector may be problematic taking into consideration the flexible opportunity provided by the Statements of Standard Accounting Practice -- SSAPs and Financial Reporting Standards -- FRSs. As an illustration of such flexibility, under SSAP 13, Research and Development, companies may within particular confinements choose to capitalize development expenditure, as a substitute to charging this expense to the P & L. account. One firm may perform this and skip the P & L. account in particular years while another may not. This will have tremendous impact on the performance ratios and making conclusions on the way the company compares against its competitors becomes more difficult. (Ratio Analysis)

Conclusion:

Accounting ratios are a significant tool applied by accountants and others for representing accounting statements. The analysts...

The ratios analysis performed in a mechanical, unthinkable manner is critical but if applied sharply with good judgment it entails valuable perception into the operational aspects of the firm.
References

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