The correct answer is: A. it is difficult to assess and rely on the average of ratios of the strong and weak firms in the industry.
Ratio analysis is a tool that can be used to compare the financial performance of different firms in the same industry. By calculating and comparing ratios, you can get a sense of how well a firm is performing relative to its peers.
However, it is important to note that ratio analysis is not without its limitations. One of the biggest limitations is that it can be difficult to assess and rely on the average of ratios of the strong and weak firms in the industry. This is because the average can be skewed by the performance of the outliers, i.e., the very strong and very weak firms.
For example, let’s say that you are comparing the financial performance of two firms in the same industry. Firm A has a debt-to-equity ratio of 0.5, while Firm B has a debt-to-equity ratio of 2.0. Based on these ratios, it would appear that Firm A is in a better financial position than Firm B. However, if you take a closer look at the financial statements of these two firms, you will see that Firm A is actually a very weak firm with a lot of debt. On the other hand, Firm B is a very strong firm with very little debt.
In this case, the average debt-to-equity ratio of the two firms would be 1.25. However, this average would not be a good representation of the financial position of either firm. This is because the average is being skewed by the performance of the outlier, i.e., the very weak firm, Firm A.
Therefore, it is important to be careful when using ratio analysis to compare the financial performance of different firms in the same industry. You should not rely solely on the average of the ratios. Instead, you should also consider the individual ratios of each firm and the financial statements of each firm.
The other options are all true statements about ratio analysis.
Option B: It helps to assess the financial standing of the firm as compared to other firms in the same industry.
Option C: It is not possible to standardise the accounting data of various firms following varied accounting policies.
Option D: Comparison of average of the industry with those of the firm can help to identify areas where the firm is performing well or poorly relative to its peers.