What is one of the limitations of ratio analysis?

Ratio analysis is a financial assessment tool used to evaluate the performance and financial health of a company by comparing key financial metrics. One significant limitation of ratio analysis is that it primarily relies on historical data. This historical focus means that the analysis provides insights based on past performance rather than considering current market conditions or predicting future trends. As a result, while it can highlight certain trends and issues, it may not fully capture the company’s current situation or future potential.

Many businesses operate in dynamic environments where market conditions, consumer behavior, and economic factors can change rapidly. Relying solely on historical data can lead to misguided conclusions, as it may not account for recent developments or upcoming challenges. Therefore, while ratio analysis is a useful tool for financial assessment, its dependence on past data is a noteworthy limitation that analysts must consider when interpreting the results and making strategic decisions.