Limitations of Financial Statement Analysis
There are any number of limitations to financial statement analysis, including these:
- The Balance Sheet presents the relationship between assets and liabilities on a specific date in the past.
- An Income Statement or the Statement of Cash Flows reflects performance over a specified period of time.
- When analyzing financial statements, remember significant changes can impact a company's financial standing after the financial information is published. Examples include: the death of an officer, loss of a major customer, expiration of a patent, loss of a major competitor, success of a recent product innovation, or infusion of additional capital.
- Financial perfomance, whether good or bad, is not a perfect indicator of future performance.
- The more out-of-date a customer's financial statements are, the less valuable they are in evaluating credit risk.
- Unaudited financial statements may contain two types of errors: (1) unintentional mistakes, or (2) intentionally fraudulent statements.
- Unless a company provides prior period financial statements for comparison, there is no starting point that can be used for comparison.
- Notes to the financial statements contain information not found anywhere but most analysts do not request or receive these notes.
- Fixed assets are shown on the balance sheet at their acquisition cost minus accumulated depreciation. The fair market value of these assets is always different from the book value.
- No open account sale is guaranteed.
- Problems in the company under review can create unexpected problems for the company.
- Audited financial statements are not always accurate.
- Analysts often have limited or no visibility to a company's off balance sheet financing
- Financial statements do not tell anything about the loss of a major customer by the target of the financial analysis.
- Foreign financial statements usually do not follow GAAP.
- Financial statements do not tell an analyst about troublesome changes in the competitive environment in which the target of the financial analysis operates.
Edited by Michael C. Dennis.