Limitations of financial ratios as a tool to evaluate financial performance Essay

Although financial ratios play a critical case in allowing investors and analysts to give appropriate predictions and a nib of how the come with will achieve in the future years in terms of stock prices and profitability but a measure problem with these ratios is that they atomic number 18 based on historical selective information and therefore an attempt to look into the future with the use of these ratios is risky and exposes investors to different kinds of risks such(prenominal) as inflation, cross-border risk and other business related risks. other limitation of these ratios is related to there limited use on there own.Certain ratios are peanut unless they compared with the older data or industry averages. This is a main reason why most analysts compulsion to compare a companys financial ratio with the industry figures. This overly means that an consciousness of the business and industry must be there with the investor before a decision is made with regards to buying th e stock of a company. We also see that firms and their finance departments do try their best to inflate results and window dress the balance sheet and profit and loss figures.This can lead to over estimated revenues and understated cost which might be discovered later. Therefore it is eventful to look at different ratios and notes to the statements before conclusions are drawn. There is also a case for companies that have defaulted or there have been instances where scams have been caught and describe by the securities companies and other government departments. Some of the financial ratios also might be impacted by the sudden change in a particular part or some economic factor that might have a short-term affect on the surgical procedure of the companys screw line and earnings per share.To counter this short-term possibility analyst must look at twain technical and fundamental analysis before deciding the long-term interpret on the company. Another bang with financial rati os is that it does not take into account off-balance sheet items that might play a significant role in the profitability and revenue generation of a company this is a case especially for investment funds banks. We also see that financial ratios only use accounting data and not economic data.This is also a downside to financial ratios as only limited data is being used to come to important conclusions. (Financial modeling guide, n. d. ) Conclusion MITIE is a strong group with businesses in strategically strong markets where long-term view is extremely positive. The company has strong financials with a prudent policy of avoiding debt in uncertain times. The company has through with(p) well considering the difficult time that has been presented by the economic recession and worldwide financial crunch. The companys profitability looks stronger as we move into 2010 and beyond.The company also has huge potential in business areas such as infrastructure oversight and property works espec ially within the public sector. We say so because a lot of options will be available and a number of opportunities present themselves specifically in the government sector. (Reilly & Brown, 2003) The financial analysis reveals important stuff about the company firstly the company has in truth few assets backed by long-term borrowing which shows that the company has an opportunity to raise finances by leveraging its balance sheet.This could be very effective if some strategic capital is bought or involution is sought by the company. We also see great potential as the liquidity and cash invest of the company s very impressive this is the case because it is very difficult to manipulate important data in the cash flow statement and the cash flow figures therefore a good performance in that sector shows great potential and the healthy performance of the company.Essentially what is of utmost importance for the company is the fact that it has successfully faced the lowest points of the e conomic cycle and more importantly it ensured that it developed sufficient policies to handle the recessionary times so that in future when liquidity crunch will draw again the company will have adequate measures in place.Appendix Bibliography Baker. H, Powell. G, 2005. Understanding financial management a practical guide. Blackwell Publishing Financial Modeling Guide, n. d. Limitations of Financial Ratios in Financial Modeling.Viewed February 6, 2010. http//www. financialmodelingguide. com/financial-ratios/financial-ratio-limitations/ MITIE, 2010. Investors at MITIE, viewed February 7, 2010 http//www. mitie. com/investors MITIE, 2010. roughly us, viewed February 7, 2010 http//www. mitie. com/about-us MITIE, 2010. Annual Report 2009, viewed February 7, 2010 http//www. mitie. com/investors_reports-and-presentations_2009_MITIE-Group-PLC-Annual-Report-2009 Reilly, K Frank & Brown, 2003. Investment Analysis and Portfolio Management, Cengage South-Western Publisher.