Limits of financial analysis

Financial analysis is useful, but it can mislead if you forget its limits.

• It inherits the limits of the financial statements: historical cost, accounting conventions and personal judgements.
• Price level changes are ignored. If profit rose 10% while prices rose 12%, the firm actually did worse in real terms.
• Changes in accounting procedure (say, a new depreciation method) can make comparisons misleading, unless you know about them.
• It studies reports only: non-monetary facts, like the quality of management or labour relations, are left out.
• Window dressing: a company may arrange its figures to look better than they really are, for example by delaying payments just before the year end.

So numbers always need context: what else is happening in the firm and in the economy.