# Limitations of Financial Ratios
Ratios are powerful, but they are not infallible. Be aware of the following limitations:
## 1. Diversified Product Lines
Firms operating in multiple industries through divisions cannot be analysed meaningfully on aggregate ratios. Inter-firm comparisons become invalid.
## 2. Distortion by Inflation
Financial data are recorded at historical cost, which may differ significantly from true (current) values. This distortion flows into the ratios.
## 3. Seasonal Factors
Financial data captured at a point in time may be influenced by seasonality (e.g., year-end inventory in a retail firm during Diwali).
## 4. Window Dressing
Firms may make year-end adjustments to make ratios like Current Ratio or Debt-Equity look favourable — changing the character of the ratio.
## 5. Differences in Accounting Policies / Periods
Two firms using different depreciation methods, inventory valuation methods, or accounting periods produce non-comparable ratios.
## 6. No Standard Benchmark
There is no universal standard for any ratio.
- Industry averages serve as a proxy.
- But if a firm aims to be above average, the average is too low a benchmark.
- For a below-average firm, the average is too high a target.
## 7. Interdependence of Ratios
Ratios are not independent. A single ratio may signal efficiency, but the set as a whole may tell a different story. Multivariate analysis (e.g., Z-score) handles this interdependence.
## Bottom Line
Ratios are a starting point, not the conclusion. Always read them together with qualitative factors, industry context, and management commentary.