Study notes

Value and Limitations of Ratio Analysis

  • Levels: AS, A Level
  • Exam boards: AQA, Edexcel, OCR, IB, Other, Pre-U

Ratio analysis is widely used in practice in business. Teams of investment analysts pour over the historical and forecast financial information of quoted companies using ratio analysis as part of their toolkit of methods for assessing financial performance. Venture capitalists and bankers regularly use ratios to support their analysis when they consider investing in, or loaning to businesses.

The main strength of ratio analysis is that it encourages a systematic approach to analysing performance.

However, it is also important to remember some of the drawbacks of ratio analysis

  • Ratios deal mainly in numbers – they don't address issues like product quality, customer service, employee morale and so on (though those factors play an important role in financial performance)
  • Ratios largely look at the past, not the future. However, investment analysts will make assumptions about future performance using ratios
  • Ratios are most useful when they are used to compare performance over a long period of time or against comparable businesses and an industry – this information is not always available
  • Financial information can be "massaged" in several ways to make the figures used for ratios more attractive. For example, many businesses delay payments to trade creditors at the end of the financial year to make the cash balance higher than normal and the creditor days figure higher too.

Join the tutor2u community

With a tutor2u account you can access extra features to support your teaching & learning.

Subscribe to the daily digest

Curate your own content

Track your training schedule

Manage your resource library

Receive job alerts

Join the community

Already joined? Sign in now ›

More From the Digital Store

A comprehensive test bank of exam-style MCQs for AQA Year 1 (AS) Business to support topic revision and exam practice.

£50.00 (+VAT)

AQA A Level Business Year 1 (AS) MCQ Test Bank (Vol1)

An exam-style and exam-standard unit assessment covering Units 3.1-3.2 of the AQA A Level Business specification, with full mark scheme.

£15.00 (+VAT)

AQA Business Unit Assessment (Units 3.1-3.2)

Entrepreneur cards is a kinaesthetic group activity designed specifically to develop students skills of analysis and evaluation in relation the characteristics of an entrepreneur.

£5.00 (+VAT)

Entrepreneur Cards

Recruitment

Advertise your vacancies with tutor2u

Much cheaper & more effective than TES or the Guardian. Reach the audience you really want to apply for your teaching vacancy by posting directly to our website and related social media audiences.

Find our more ›

Advertise your teaching jobs with tutor2u