6. Useful in Identifying the weak areas: Ratio analysis assists in identifying weak areas in the business even though the overall performance may be satisfactory. Management can pay attention to the weaknesses and take remedial action. Limitations of Ratio Analysis The limitations of accounting ratios are: 1, Misleading if based on Incorrect Information: Ratios are calculated from the financial statements, thus, the reliability of ratios and their analysis is dependent upon the correctness of the financial statements. If the Financial Statements are misleading, the analysis will also show false picture. 2. Definitions of Terms not Standardised: Elements and sub-elements of financial statements are not defined in a unique manner. An enterprise may compute ratios on the basis of profit after interest and income tax; another enterprise may consider profit after interest but before tax; yet a third enterprise may take profit before interest and tax. 3, Not Comparable if Different Firms follow Different Accounting Policies: When results of two enterprises are being compared, it should be kept in mind that the enterprise may follow different accounting policies. For example, one enterprise may charge depreciation on the straight-line basis and the other on diminishing value basis. Such differences will adversely affect the comparison of the financial statements. 4. Effect of Price Level Changes: Change in price level affects the comparability of ratios, But price level changes are not considered in the accounting variables from which ratios are computes. This handicaps the utility of accounting ratios. 5. Ignores Qualitative Factors: Ratio analysis is a technique of quantitative analysis not qualitative analysis, which is important in decision-making. For example, average collection period may be equal to standard credit period, but debtors may be in the list of doubtful debtors, which is not disclosed by ratio analysis. 6. Limitation of a Single Ratio: A single ratio cannot be explained and no decision can be taken on its basis. For example, X Limited has a Current Ratio of 2 : 1.5 can only tell that when current assets are 2, current liabilities are 1.5. Hence, a single ratio is of less use.Meaning of Ratio Analysis Ratio analysis means establishment of meaningful relationship between components of financial statements. “Ratio analysis is a study of relationship among various financial factors in a business”. - Myen Ratio analysis is a technique of analysing the financial statements. Itis a process of determining and interpreting relationships between the related or interdependent items of financial statements to have a meaningful understanding of the performance and financial position of an enterprise. Ratio analysis is also an accounting tool to present accounting variables in a simple, concise, explainable and understandable form. Advantages of Ratio Analysis The advantages of ratio analysis are: 1. Useful in Analysis: Accounting ratios are useful for understanding the financial position of the enterprise. Bankers, investors, creditors, etc., all analyse Balance Sheet and Statement of Profit and Loss by means of ratios. 2. Useful in simplifying Accounting Information: Accounting ratio simplifies, summaries and systematises a long array of accounting information to make them understandable. Its main contribution lies in communicating precisely the interrelationships which exists between various elements of financial statements. 3. Useful in Assessing the Operating Efficiency of Business: The management can determine the operating efficiency of business with the help of Activity Ratios such as Inventory Turnover Ratio, Trade Receivables Turnover Ratio and Working Capital Turnover Ratio etc. 4. Useful in Determining Profitability: Management and investors can determine the profitability with respect to Revenue from Operations and Capital Employed with the help of Profitability Ratios such as Gross Profit Ratio, Net Profit Ratio, Operating Ratio, Return on Investment, etc. 5. Useful for Forecasting: Ratios are helpful in business planning and forecasting. The trend of ratios is analysed and used as a guide to future planning. What should be the future course of action is decided, many a times, on the basis of trend of ratios, i.e. ratios are calculated for a number of years.