Financial Statements Analysis
Financial analysis has proven to be an important tool in determining the profitability of a business, the viability of an investment, and the future direction of investment. However, it does not lack its limitations as stated by accounting tools (2018) in that;
- Inflationary effects. Assets recorded usually have low inflation as compared to the real inflation rate because they are not adjusted to keep up with the same, especially in cases of long term assets.
- Specific period. Financial statements and analyses are based on a particular period, and an investor analyzing the financial statements to determine the position of the firm may miss any current changes in the firm. For example, a firm’s slump in its sales or revenue generated.
- They may be a fraud in that the company employees and top management may collaborate to skew the financial reports to make them appealing to the public and investors to invest in their firms.
- Intangible assets are not included in the financial statements. Once recorded, they are recorded on their value of acquiring them as expenses hence missing on that position of the firm.
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- The financial statements record transactions based on their initial costs, which may miss out on the current change of their prices either upwards or downwards hence overvaluing or undervaluing these transactions.
- Many companies use different accounting methods, which make it difficult for the public or investors to compare different firms in the same industry to choose which the best to invest is.
- Non-financial aspects of a firm are not addressed in the financial analysis in that they miss out on essential operations of the firm like how the activities of a firm affect the environment and how the firm benefits or affects the local community.
Reference
Accounting tools (2018). Limitations of financial statements. Retrieved from www.accountingtools.com/articles/limitations-of-financial-statements.html