What are the limitations of ratio analysis, and how should non-financial and ethical factors inform a financial decision?
Explain the limitations of ratio analysis, evaluate the role of non-financial and ethical factors in decision-making, and recommend a course of action using both financial and qualitative information
WACE Year 12 Accounting and Finance Unit 4 on the limitations of ratio analysis and decision-making: why ratios can mislead, the role of non-financial and ethical factors, and how to combine financial and qualitative information into a recommendation.
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What this dot point is asking
SCSA wants you to explain why ratios can mislead, evaluate non-financial and ethical factors, and reach a justified recommendation using both.
Limitations of ratio analysis
Because of these limits, ratios are best used as a group, compared over time and against similar businesses, and read alongside the notes to the accounts.
Non-financial factors
A decision based only on numbers can be poor. Non-financial factors include the skill and morale of staff, the strength of the brand and customer loyalty, the state of the economy and competition, the quality of management, and legal or regulatory changes. These can outweigh a favourable set of ratios, or rescue an investment that looks weak on paper.
Ethical factors
A decision that maximises short-term profit might damage the environment, mistreat workers or mislead customers, harming the business's reputation and long-term value. Ethical and financial considerations therefore often point in the same direction over the long run.