Limitations of Financial Statement Analysis

Financial statement analysis is a useful tool for evaluating the financial health of a company. However, it has some limitations that must be considered while interpreting the results.

Ignores the Qualitative Elements

Financial statements provide quantitative data, such as numbers, ratios, and percentages. It does not consider non-financial factors like management quality, employee morale, market trends, and industry competition. It is crucial to consider qualitative aspects while analyzing financial statements to get a complete overview of a company's financial health.

Not Free from Personal Bias

Financial analysis is prone to personal bias and interpretation. The analysis depends on the analyst's skill, knowledge, and experience. Different analysts may have different opinions and conclusions, leading to varying results. Therefore, it is essential to consider multiple viewpoints and reach a consensus before making any decisions.

Intra-firm Comparison

Financial statement analysis focuses on intra-firm comparison, which means comparing a company's financial performance over time or against its own historical data. It does not provide any insight into how a company is performing compared to its competitors or the industry average. Therefore, it is essential to compare a company's financial performance with its peers to identify its competitive position and adjust strategies accordingly.

Ignores Price Level Changes

Financial statement analysis ignores the impact of price level changes on a company's financial performance. Inflation and deflation can distort the financial statements, making it difficult to compare the performance of the company over time. Therefore, it is necessary to consider the effect of price level changes while interpreting the results.

Conclusion

In conclusion, financial statement analysis is a powerful tool for evaluating a company's financial health. However, it has some limitations that must be considered while interpreting the results. By taking into account the qualitative elements, avoiding personal bias, performing inter-firm comparison, and adjusting for price level changes, one can get a more accurate picture of a company's financial performance.

Ans - [C] Intra - firm comparison

Reason : Financial Statement Analysis helps a business organisation to facilitate Intra firm comparison. Thus, helping in checking out where the company or firm stands.