Explain the purpose of ratio analysis and describe its limitations as a tool for evaluating the financial statements of a business?

The purpose of ratio analysis is to evaluate the financial performance and stability of an entity.

It helps internal and external users analyse financial statements by examining ratios that describe the quantitative relationship between two data items.

Ratios can be used to perform a trend analysis or they can be compared with a predetermined budget or previous periods for the same entity.

In addition, can they can be compared with ratios for competitors or industry benchmarks.