Profitability ratios are distorted by inflation because profits are stated in current dollars and assets and equity are stated in historical dollars.

Question

Quizplus · Accepted Answer

Profitability ratios such as return on investment, return on equity, and gross profit margin are affected by inflation because profits are calculated in current dollars, which do not reflect the inflationary pressures. On the other hand, assets and equity are stated in historical dollars, which may not accurately reflect their current value or purchasing power. Thus, profitability ratios may give a distorted picture of a firm's true financial position in an inflationary environment.

Profitability Ratios Are Distorted by Inflation Because Profits Are Stated