In spite of the fact that financial analysis is very useful in deciding financial strengths and weaknesses of a company, its correctness depends on the information available in financial statements. In that capacity, the financial analysis also suffers from limitations of the financial statements.
Therefore, the analyst who makes the analysis of financial statements must possess the knowledge of the various aspects that can hamper the financial analysis. He should be well aware of the impact of cost price level changes, any changes in accounting policies of an enterprise, window dressing of budget summaries or books of accounts, individual judgment, accounting concepts and policies, accounting conventions, and so on.,
Some other limitations of financial analysis may include:
- Price level changes not considered – Financial analysis does not take into account any changes related to price level. This may render the analysis of financial statements less useful.
- Inaccurate financial statements – The accuracy of financial statement data is not possible in light of the fact that the statements deal with matters which can’t be stated. The data are recorded by traditional methods followed over the years. Different conventions, postulates, individual decisions and so forth are utilized for developing the data.
- Non-monetary data ignored – The financial statements record transactions that can be valued in money. It does not take into account any non-monetary data which might have a huge impact on business of the company.
- Unawareness of the concepts followed by the company – The financial analysis may be ambiguous without the prior knowledge of the adjustments in accounting procedure followed by the company.
- Does not take into account the current conditions – The financial statements are prepared on the basis of historical costs or original costs.. The statements are not prepared keeping in mind the present economic conditions.
- Restricted to financial statements – Financial analysis is just evaluation and interpretation of the financial reports of the company. It does not consider any other factors which might affect the performance of the company.
Thus, it can be concluded that financial analysis would inherit any limitations faced by the financial statements of the company, since analysis is based on the Balance Sheet, Income Statement, Cash Flow Statement and other financial reports. Other than the inherent limitations, there are quite a few other limitations too which might make the financial analysis less useful.