Discuss the purpose and importance of financial ratios and financial analysis. What are the limitations of financial ratio analysis? If we divided the users of financial ratios, such as short-term lenders, long-term lenders, and stockholders, which ratios would each prefer and why? Provide examples.
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750 – 1250 words (3 – 5 pages of content/body) paper, APA 7th edition. At least three external references.
Requirements: APA | Essay | 4 pages, Double spaced
Answer preview
Despite financial ratios being of importance to a company, they have some limitations and any company applying them should do so with caution. The following are various limitations of financial ratios. The first one is that there can be biasness when interpreting different ratios for instance debt to equity or return on capital since companies operating in different industries have different rates of growth depending on their sources of finance. Secondly, financial ratios do not consider different sizes of companies and this affect the way formulas like interest coverage ratios need to be interpreted. Thirdly, ratios use accounting figures given in financial statement and these figures are subject to approximations or even manipulation and therefore these ratios are not reliable in drawing conclusions (Musallam, 2018). The other limitation is that financial ratios are subject to problem of comparability since companies use different accounting methods
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