What is one limitation of ratio analysis when comparing organizations?

Ratio analysis is a valuable tool for assessing and comparing the financial health of organizations. However, one significant limitation arises when comparing organizations that operate in different industries. Each industry has its own unique financial dynamics, capital structures, and operating practices, which can result in varying benchmarks for financial ratios. For instance, a retail company may have different profit margins and inventory turnover ratios compared to a manufacturing company due to the nature of their operations and the economic factors affecting each sector. As a result, using ratio analysis across different industries can lead to misleading conclusions, as the ratios may not be directly comparable in terms of performance and efficiency.

In contrast, organizations operating within the same industry generally follow similar financial practices, making ratio analysis a more effective tool for comparison in those cases. This context underscores the importance of industry-specific benchmarks when utilizing ratio analysis for financial comparisons among organizations.