Accounting and financial statements include the Statement of Financial Position, financial reports, and other financial reports, all of which must be formatted in line with the appropriate financial reporting framework. However, due to the volatility nature of the sector, business circumstances, and other factors that impact the financial statements, auditors and many other experts are unable to offer a comprehensive report due to limitations of financial statement analysis.
Performing FSS (Financial Statement Study) means analyzing of financial statements, which is carried out by a financial analyst, in order to help businesses, keep disadvantages of financial statement analysis aside and make logical business decisions. Financial statement analysis is the act of transforming the raw financial data included in financial statements into usable information that can be used to make decisions.
- 1 Top 10 – Limitations of Financial Statement Analysis
- 1.1 Several Types of Accounting Policies, Estimates and Methods
- 1.2 Does Not Consider Changes in the Level of the Price
- 1.3 Information That Is Inaccurate
- 1.4 Not Intended to be a Substitute for Decision Making
- 1.5 Contemporary Data for Financial Statement Analysis
- 1.6 Modifications in the Operating Environment
- 1.7 The Accuracy and Trustworthiness of the Information
- 1.8 Prejudice is Still Present
- 1.9 Timeliness and Relevancy
- 1.10 Use of the Tools for Analysis is Subject to Certain Restrictions
- 2 Conclusion
Top 10 – Limitations of Financial Statement Analysis
There are key top 10 limitations of financial statement analysis in business despite the fact that financial statements provide a number of advantages of financial statement analysis. The fact that the analysis is conducted on the basis of information included in the financial statements raises the possibility that the results may be incorrect.
Several Types of Accounting Policies, Estimates and Methods
In order to determine the value of inventories, fixed assets, and investments, for example, management relies on a number of methodologies and accounting rules, as well as estimates made by the company’s management team.
Furthermore, unless the approach or policy used is expressly prohibited by law, the auditor or financial analyst is not permitted to express any reservations or reservations about it. Therefore, the varied techniques and assessments provide a limitations of financial statement analysis set of findings and, as a result, a diverse set of financial situations.
Does Not Consider Changes in the Level of the Price
The financial analysis does not take into consideration the change in the level of the price. Rather of utilizing real values, the statistics for different years are generated using notional values rather than actual values.
Information That Is Inaccurate
Consequently, the financial analysis has been unable to find any major changes in accounting procedures and practices as a result of the decision. As a result, they may provide information that is inaccurate or misleading.
The following are some examples of limitations of financial statement analysis: The Enron scandal, which initially came to light in October 2001, was one of the biggest accounting frauds in history, garnering widespread attention from media outlets across the globe. In order to conceal huge amounts of debt that had accrued as a result of unsuccessful deals and initiatives, the company’s CEO, Jeffrey Skilling, faked the financial accounts. The share price of this firm hit a high of USD 90.75 in the middle of 2000 before plunging to less than USD 1 upon the exposure of the fraud in late 2000. These are the kind of repercussions that might result from financial statement misrepresentation.
Not Intended to be a Substitute for Decision Making
In the absence of a thorough examination of financial statements, competent judgement cannot be substituted. It is only a means to a goal, rather than an end in and of itself. Interested parties or analysts make final decisions based on their intelligence and ability to make a choice in the context of a particular situation. This is one of the foremost important disadvantages of financial statement analysis which business owners should look into it on priority.
Contemporary Data for Financial Statement Analysis
The auditor and various analysts base their judgments on a variety of factors, including historical data, present conditions and outcomes, and other considerations. In the event that there has been an improvement, they will provide positive reports.
Analysis they do not take into account the enterprise’s long-term objectives as well as the economy’s and market’s long-term circumstances because these factors might alter at any time owing to the unpredictable nature of the world. As a result, it is not necessary that a report that contains beneficial findings in the future will always have favorable findings, because the conditions under which the report was generated are susceptible to change.
Modifications in the Operating Environment
A lot of things happen in the markets that are completely unforeseen; market situations and conditions may alter at any point in time, sometimes leading to a recession and other times leading to favorable market conditions.
Considering that one’s reports are based on current circumstances, which may or might not be the same at all times and might or might not change in the future, one should be aware limitations of financial statement analysis and unfavorable conditions that can turn into favorable ones and vice versa as one is writing them.
The Accuracy and Trustworthiness of the Information
While everyone wants to attract investors in today’s world of competition, one method of doing so is by window dressing the financial statements and portraying the firm in a more favorable light. The dependability of the financial statements and reports given by the enterprise’s management is established by the auditor and various analysts, although the statistics are only verified on a test check basis by the auditor and numerous analysts.
Consequently, the credibility and transparency of reports generated by independent third parties are susceptible to the limits imposed by management on the reliability and openness of the reports they provide.
Prejudice is Still Present
Many elements on the Financial Statements’ balance sheet and income statement are determined mostly by the accountant’s and management’s own judgement and discretion, which plays an important role in determining the statistics.
Due to the fact that depreciation, provision for doubtful debts, stock value (and other comparable elements) all rely on personal judgement, it is impossible to ensure that financial statements are fully error-free. It is possible to make a similar argument regarding the lack of objectivity and the disadvantages of financial statement analysis.
Timeliness and Relevancy
It is important to remember that a financial statement analysis has a shelf life just like any other data, report, or analysis, and that it must be respected. Because we live in a dynamic world, assisted by the wonders of the internet, things are changing at an alarmingly quick rate these days, and this is a good thing. Beyond being effective, an analysis must also be created and consumed within an acceptable time limit, failing which it loses its value and becomes ineffective.
In order for an analysis to be completed, it must be carried out in response to particular conditions that exist at the moment of completion. The analysis will become less useful or perhaps entirely useless if those circumstances change in the future. The result is that any reader or prospective investor who comes across analysis at this stage may find himself or herself in a position where he or she must make an incorrect decision.
Use of the Tools for Analysis is Subject to Certain Restrictions
Analysts utilize a number of different tools while conducting research and analyzing data. Despite the fact that the skill and experience of the analyst have a role in the application of a certain tool or method, there are some disadvantages of financial statement analysis and basic recommendations to follow. In the event that an unsuitable instrument or technique is utilized, it is inescapable that the findings will be misleading.
Top-10 limitations of financial statement analysis for an organization, corporate and business that are produced, such as its dependence on present and historical conditions, which can alter at any point in the future. A comparison of the financial performance of two firms is not suitable due to the fact that every business utilizes a unique set of accounting rules and procedures.
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