Q.Explain any two Limitations of Ratio Analysis.
🔒You're viewing a preview — the full solution, concept, methods & PYQ mapping are locked.
🔒 Start your 14-day free trial to unlock the full solution →Concept understanding — Ratio Analysis
Let’s start with something you already know. Suppose you and a friend both run small shops. You each put in ₹1,00,000. At the end of the year, your shop made a profit of ₹20,000; your friend’s shop made ₹30,000. Which shop is doing better? The obvious answer is your friend’s — more profit. But what if your friend had to borrow ₹2,00,000 to earn that ₹30,000, while you used only your own ₹1,00,000? Suddenly, your shop looks more efficient. You are now thinking in ratios: profit relative to the money used.
That is the core of Ratio Analysis. It is not about raw numbers; it is about relationships between numbers. A ratio is simply one figure divided by another. In accounting, we use ratios to judge a business’s performance, financial health, and efficiency — without being misled by size.
What the NCERT textbook says
The NCERT Class 12 Accountancy textbook (Part II, Chapter 5) defines Ratio Analysis as:
“Ratio Analysis is a technique of analysis of financial statements to assess the profitability, liquidity, solvency and efficiency of a business enterprise.”
It is a tool, not a separate account. You do not “debit” or “credit” a ratio. Ratios are calculated from the figures already recorded in the Trading and Profit & Loss Account and the Balance Sheet.
Why does it matter?
Three big reasons:
- Comparison – You can compare a small firm with a large one, or the same firm over different years, because ratios cancel out size.
- Decision-making – A bank deciding whether to give a loan looks at liquidity ratios. An investor looks at profitability ratios.
- Early warning – A falling current ratio may signal trouble paying bills, even if profits look fine.
Accounting treatment: No debit/credit
This is a common confusion. Ratio Analysis is not a journal entry. You never write:
“Debit Ratio Analysis, Credit Profit & Loss Account”
That would be wrong. Ratios are computed after the final accounts are prepared. They are presented in a separate statement called a Comparative Statement or Common Size Statement, or simply listed in a report.
Where a format/proforma is given
The NCERT textbook gives a format for Comparative Balance Sheet and Comparative Statement of Profit & Loss. These are the main vehicles for ratio analysis. Here is the proforma for a Comparative Balance Sheet as per NCERT:
| Particulars | Note No. | Previous Year (₹) | Current Year (₹) | Absolute Change (₹) | Percentage Change (%) |
|---|---|---|---|---|---|
| I. EQUITY AND LIABILITIES | |||||
| 1. Shareholders’ Funds | |||||
| (a) Share Capital | |||||
| (b) Reserves and Surplus | |||||
| 2. Non-Current Liabilities | |||||
| (a) Long-term Borrowings | |||||
| 3. Current Liabilities | |||||
| (a) Trade Payables | |||||
| (b) Short-term Provisions | |||||
| Total | |||||
| II. ASSETS | |||||
| 1. Non-Current Assets | |||||
| (a) Fixed Assets | |||||
| (b) Non-Current Investments | |||||
| 2. Current Assets | |||||
| (a) Inventories | |||||
| (b) Trade Receivables | |||||
| (c) Cash and Cash Equivalents | |||||
| Total |
Ratio analysis has limitations because ratios are based only on figures and ignore qualitative and price-level factors. …
Ratio analysis is only as reliable as the figures it uses - it ignores qualitative and price-level factors.
Limitations of ratio analysis (any two):
- IGNORES QUALITATIVE FACTORS - ratios use only monetary/quantitative data and ignore qualitative aspects such as the quality of management, labour relations and market reputation.
- AFFECTED BY PRICE-LEVEL CHANGES - ratios are based on historical cost figures and do not adjust for inflation, so a comparison over years can be misleading. …
Showing the 12 most recent of 47 on this concept.
- CBSE 2026Set MARCH1 markMCQQ.For which of the following items the ratio is computed in days?(a) For total purchase(b) For credit sales(c) For credit purchase(d) Both (B) and (C)
›Reveal solutionSolution
Ratios computed in days apply to both credit sales and credit purchases, so the answer is (d).
Certain activity ratios are stated as a number of days:
Ratio Based on Expressed in Debtors / Receivables collection period Credit sales Days Creditors / Payables payment period Credit purchases Days … - CBSE 2026Set MARCH1 markMCQQ.Which of the following is correct for accounting ratios?(a) Comparison with ratios developed by the firm(b) Comparison with ratios of industry(c) Comparison with ratios of competitors(d) All of the above
›Reveal solutionSolution
Accounting ratios can be compared with the firm's own, industry and competitors' ratios, so the answer is (d).
Ratio analysis is a comparative tool. A ratio is judged good or bad only against a benchmark, which may be:
- the firm's own ratios of earlier years (intra-firm/trend comparison),
- the average ratios of the industry, and …
- CBSE 2026Set MARCH1 markQ.Expand R.O.I.
›Reveal solutionSolution
R.O.I. stands for Return on Investment.
Return on Investment (also called Return on Capital Employed) is a profitability ratio that shows how efficiently the capital employed in the business has been used to generate profit.
…
- CBSE 2026Set ANNUAL1 markMCQQ.If the market price of a company is ₹ 16 per share and earning per share is ₹ 3.2, then the price earning ratio will be A) ₹ 0.20 B) ₹ 5 C) ₹ 16 D) Cannot be determined
›Reveal solutionSolution
The price-earning ratio is 5 - option (B).
Price-Earning (P/E) Ratio = Market Price per Share / Earnings per Share (EPS)
= 16 / 3.2
= 5 times.
…
- CBSE 2026Set ANNUAL1 markMCQQ.Assertion(A) : Accounting ratio is a mathematical expression of relationship between different items of the group of items in the Financial Statements for two consecutive years. Reason (R) : Accounting ratio is a mathematical expression of relation between two items of the group of items in the Financial Statement. In the context of the above statements, which of the following is correct?(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A)(b) Both Assertion (A) and Reason (R) are true but Reason (R) is not the correct explanation of Assertion (A)(c) Assertion (A) is true but Reason (R) is false(d) Assertion (A) is false but Reason (R) is true(a) Both Assertion (A) and Reason (R) are true and Reason (R) is the correct explanation of Assertion (A)(b) Both Assertion (A) and Reason (R) are true but Reason (R) is not the correct explanation of Assertion (A)(c) Assertion (A) is true but Reason (R) is false(d) Assertion (A) is false but Reason (R) is true
›Reveal solutionSolution
Assertion (A) is false but Reason (R) is true (Option D).
An accounting ratio is simply a mathematical expression of the relationship between two related items (or groups of items) taken from the financial statements of the SAME accounting period — for example, Current Assets to Current Liabilities, or Net Profit to Revenue from Operations, both for the same year. It does not require, and is not defined using, figures 'for two consecutive years' as stated in Assertion (A); ratios for two different years are only needed when doing trend/comparative analysis of the SAME ratio across years, which is a separate exercise from the basic defini …
- CBSE 2026Set ANNUAL1 markMCQQ.Or. When a firm's total asset turnover ratio increases, it indicates(a) assets are being used more efficiently to generate sales(b) assets are being underutilized(c) sales have decreased(d) fixed assets have increased
›Reveal solutionSolution
A rising Total Asset Turnover Ratio shows the firm is generating more sales per rupee of assets employed — a sign of improving efficiency, not a decline.
Total Asset Turnover Ratio = Net Sales (Revenue from Operations) ÷ Total Assets
This ratio is an efficiency/activity ratio that reveals how effectively a company is using its entire base of assets (both fixed and current) to generate sales revenue. A higher (or increasing) ratio means the company is generating more sales for every rupee tied up in its assets — i.e., its asset base is being put to more productive, efficient use. This could result from growing sales without a proportionate rise in assets, or from the company trimming down unproductive/idle assets while maintaining its sales level.
Conversely, a falling ratio would suggest assets are becoming underutilized relative to the sales they generate — the opposite of what this question describes.
The other options are incorrect because: …
- CBSE 2025Set 67/6/11 markMCQQ.The Current Ratio of Magnum Ltd. is 2·5 : 1. Which of the following transactions will result in decrease in this ratio ? (A) Purchased goods for cash ₹ 73,000 (B) Cash collected from debtors ₹ 41,000 (C) Outstanding salaries paid ₹ 62,000 (D) Repayment of long term loan ₹ 8,00,000
›Reveal solutionSolution
The Current Ratio will decrease only in transaction (D) Repayment of long-term loan ₹8,00,000. Transactions (A), (B), and (C) either keep the ratio unchanged or increase it.
The Current Ratio is Current Assets divided by Current Liabilities. A ratio of 2.5:1 means for every ₹1 of current liability, the firm has ₹2.5 of current assets. To see whether a transaction decreases this ratio, you must check what happens to both the numerator (current assets) and the denominator (current liabilities). The ratio falls when current assets decrease more than current liabilities, or when current liabilities increase more than current assets.
Let's examine each option one by one.
(A) Purchased goods for cash ₹73,000
Cash (a current asset) goes down by ₹73,000. Goods purchased become inventory (also a current asset), which goes up by ₹73,000. One current asset replaces another — total current assets remain unchanged. Current liabilities are not affected. So the ratio stays exactly the same.
(B) Cash collected from debtors ₹41,000
Cash (current asset) increases by ₹41,000. Debtors (current asset) decrease by ₹41,000. Again, one current asset replaces another. Total current assets are unchanged. Current liabilities are untouched. The ratio does not change.
(C) Outstanding salaries paid ₹62,000
Outstanding salaries are a current liability. When you pay them, cash (current asset) decreases by ₹62,000, and the liability (outstanding salaries) also decreases by ₹62,000. Both numerator and denominator fall by the same amount. For a ratio greater than 1 (here 2.5), reducing both by the same rupee amount actually increases the ratio. Let's test with assumed numbers: suppose current assets were ₹2,50,000 and current liabilities ₹1,00,000 (ratio 2.5). After paying ₹62,000, current assets become ₹1,88,000 and current liabilities become ₹38,000. New ratio = 1,88,000 ÷ 38,000 = 4.95 (approx). So the ratio increases, not decreases.
(D) Repayment of long-term loan ₹8,00,000 …
- CBSE 2025Set MARCH1 markQ.What is ratio?
›Reveal solutionSolution
A ratio is the mathematical relationship between two related accounting figures, expressed as a pure number (times), a proportion, or a percentage, used to analyse and interpret financial statements.
In GSEB Class-12 Commerce Accountancy (Accounting Ratios):
- A ratio shows how one figure relates to another (e.g., current assets to current liabilities).
- It can be expressed as a pure ratio (2 : 1), a quotient/times (2 times), or a percentage (25%). …
- CBSE 2025Set MARCH1 markQ.Expand RONW.
›Reveal solutionSolution
RONW stands for Return On Net Worth.
Return on Net Worth (also called Return on Shareholders' Funds/Equity) is a profitability ratio computed as (Net Profit after tax and preference dividend ÷ Shareholders' Funds) × 100. It tells the equity owners how much profit the firm earned on every r …
- CBSE 2025Set ANNUAL1 markQ.What do you mean by profitability ratio?
›Reveal solutionSolution
Profitability ratios measure earning capacity relative to sales, capital or assets.
A profitability ratio is an accounting ratio that measures the overall efficiency and earning power of a business by relating its profit to sales, to capital employed, or to assets. These ratios show how effectively management has used the firm's resources to generate profit. Common examples include the Gross Profit Ratio, Net Profit Ratio, Operating Ratio, Operating Profit Ratio and Return on Investment (Return on Capital Employed). They are of great interest to owner …
- CBSE 2025Set ANNUAL1 markMCQQ.Which of the following is not a profitability ratio?(a) Gross profit ratio(b) Net profit ratio(c) Operating ratio(d) Current ratio
›Reveal solutionSolution
The current ratio is not a profitability ratio - option (d).
Profitability ratios measure the earning capacity of a business and include the gross profit ratio, net profit ratio and operating ratio. The current ratio, however, is a liquidity ratio - it compares current assets with current liabilities t …
- CBSE 2025Set ANNUAL1 markQ.Answer in one word/sentence: What does accounting ratio signify?
›Reveal solutionSolution
Answer: The relationship between two accounting figures.
An accounting ratio is an arithmetical relationship between two related figures taken from the financial statements (e.g. current assets to current liabilities). It signifies and measures that relationship so that …
🎓Unlock everything free for 14 days
- ✓Full step-by-step solutions
- ✓Concept-first explanations
- ✓Methods, shortcuts & mistakes
- ✓PYQ mapping + timed mock tests
Full access for 14 days. No credit card required.