Ratios have the following weaknesses:
1. They ignore the size of the firm being compared e.g in cross-sectional analysis, the firm being compared might be of different size, technology and product diversification.
2. Effect of inflation:
Ratio ignores the effect of inflation in performance e.g increase in sales might be due to increase in selling price caused by inflationary pressure in the economy.
3. Ratios ignore qualitative or non-quantifiable aspects of the firm e.g important assets such as corporate image, efficient management team, customer loyalty, quality of product, technological innovation etc are not captured in ratio analysis.
4. Ratios are computed only at one point in time i.e they are subject to frequent changes after computation e.g liquidity ratios will constantly change as the cash, debtors and stock level changes.
5. Monopolistic firms
It is difficult to carry out industrial and cross-sectional analysis for monopolistic firms since they do not have competitors and they are the only firms in the whole industry e.g Telkom-Kenya, East Africa Brewery etc.
6. Historical Data – Ratios are computed in historical information or financial statement thus may be irrelevant in future decision-making of
7. Computation and interpretation
Generally some ratios do not have an acceptable standard of computation. This may differ from one industry to another. E.g the return on investment may be computed as:
Return on investment = EBIT or EAT
Total assets Total assets
8. Different accounting policies – Different firms in the same industry use different accounting policies e.g methods of depreciation and stock valuation. This makes comparison difficult.