When relying on financial statements, it’s crucial to be aware of their limitations. While these documents provide valuable insights into a company’s financial health, they have certain constraints that can impact decision-making. Here are six major limitations you should consider:

1. Dependence on Historical Costs

Financial transactions are recorded at their original cost, which might not reflect the current market value of assets and liabilities. For instance, while marketable securities are updated to match market values, fixed assets are not. This reliance on historical costs can make the balance sheet misleading, especially if significant assets are recorded at outdated values.

2. Potential Bias in Reporting

Financial statements are influenced by the accounting principles, conventions, and personal judgments of the accountants involved. These subjective elements can introduce bias, meaning the financial position depicted might not fully represent the company’s true situation.

3. Significant Data Omission

Certain critical information, such as the impact of losing a market or the termination of major contracts, is not reflected in the balance sheet. This missing data can lead to an incomplete understanding of the business’s financial health.

4. Aggregate Information

Financial statements present aggregated data rather than detailed breakdowns. While this summary can be useful, it may not provide enough specific information to make well-informed decisions.

5. Potential Non-Realization of Assets

The values of assets listed in the balance sheet are based on certain accounting conventions. However, if the company faces liquidation, these assets may not realize their recorded values. This discrepancy can be significant in assessing the true financial position.

6. Interim Nature of Reports

The profit and loss statement only reflects a company’s performance over a specific period. Similarly, the balance sheet shows the financial position at a particular moment, without indicating how it might change in the future. These are interim reports that don’t necessarily predict long-term trends.