The Simplifying Financial Information - Essay Example

The standardized scope of financial ratios also limits quantitative aspects of the communicated information because the ratios do not communicate exact values of financial information. Profitability is, for example, expresses in ratios and a firm with a relatively lower profit level may report a higher profitability ratio than a firm that has recorded higher profit volume. Ratios also assume a linear relationship between variables and this mislead stakeholders because most variables are not linearly related (Lee, 2006).

Investors could use liquidity ratios to make decisions, on whether to invest in a company or not, by comparing the ratios to the value one. Ratios that are less than one means that a company is overwhelmed by debt, is liable to creditors’ terms, and should inform a potential investor against the company. Ratios, which are greater than one, however, mean an organization’s independence from creditors’ adverse influences and offer short-term stability for investment. Investors can also use the magnitude of liquidity ratios to understand the level of a company’s liquidity for investment decisions because a more liquid company is more secure for investors’ short-term interests (Lee, 2006).