CHAPTER ONE
1.0
INTRODUCTION
1.1
Background of the Study
The complex
nature of today’s
business world and
the
transformation of the entire
world into a global village have been of great concerns to manages of all forms
of business organizations. According to Ojuigo (2001), the problems of managers
are multi:-varied because of inefficiency in management of poor decision outcomes
of these organizations. Therefore, the managers are unable to achieve the
organizational objective within a period of time.
As diverse as business is,
its controllable and uncontrollable factors influence all decisions which
ultimately lead to the realization of set objectives. To achieve this,
management needs reliable, authentic and relevant information from the
financial statements to efficiently facilitate decision making.
It must be noted that every
business stores at making at least from investments “sustainable profits” so as
to stay afloat and continue in business. Therefore, profit being the concern of
every manager is a factor in business. To achieve this, available information
from the financial statements of organizations must be analysed, interpreted
and used as a basis for decision making (Needham and Dransfield 1991).
Financial statement analysis is often considered as a vital tool used in
evaluating a company’s
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performance and ensuring
that decisions are based on facts rather than rule of thumb.
A financial analyst needs
financial statements of companies to be able to identify operating and
financial problems which may affect the companies (Mbat, 2001:60). Thus, any
person who analyses the financial statements of firms should be able to
identify the cause and effect of financial and operating problems of such
firms.
The cause of any financial
or operating problem is an event, which produces an effect (the problem).
However, in order to identify the cause and effect, the system, which
represents an indictor f the problem, should be observed. This process is
referred to as interpretation (Pandey, 2005). According to (Mbat, 2001), it is
the responsibility of the financial manager or analyst to enable them make
better management decisions.
The symptoms could be:
-
Declining
liquidity
-
Declining
profit
-
External
debt recovery period
-
Increased
volume of inventory
-
Declining return on total assets
-
Increasing operating expenses etc
The identification of causes
should also be important in order to appropriately evolve corrective measures.
Financial analysis and interpretation assist
in the:
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-
Identification of organizational performance
through the use of analystical data.
-
Identification of empirical relationships
between operating results and those items which have influenced the achievement
of the results.
-
Identification of historical data order to
determine which internal or external factors have exerted positive or negative
influence on the operating results (Mbat 2001:61).
Categorically, there are
three forms of financial analysis. These include: multivariate, univariate and
ratio analysis (Welsh, 1987). Moreover, ratios are the end results of basis
analysis. The ratio requires an interpretation on the basis of their trends and
in the lights of what is known of the business as a young concern. It should be
noted that financial statements represent the positions of a firm at a
particular point in time.
However, the success or
failure of a business depends largely on the quality of decisions made by
management, which in turn depends on reality of accounting information
available on them.
Research into this area is
quite relevant given the apparent investment failures experienced by many
business organizations. The collapse of many business either private or public
is due to poor decision. The question is whether management has used
information provided in the financial statement extensively to enable rational
decision making?
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The principal aim of making
investment decision is to get adequate returns from it. According to Needham
and Dransfield (1991), “people as a rule will only tie up their money in a
business if they are satisfied with the returns they get from it”.
In an attempt to achieve
maximum returns from investment in production, services shares or stock and/or
other securities outside the firm, a comprehensive analysis of the company
which is intended to be invested in should be carried out using the company’s
financial statements to ascertain both its explicit and implicit investment
opportunities. However, organizations that do not use financial statement
analysis in making investment decisions could be ill formed. As a result, the
following problems may arise:
(i)
Inability
to identify viable investment opportunities
(ii)
Decreasing
returns from investments.
(iii)
Decline
in organizational overall profitability.
(iv)
Increased investment risk: The organization
might not achieve its corporate objective at the end of the period.
If the trend continues, it
will likely lead to the failure of the organization. Therefore, there is a
great need for organizations to consider and analyse company’s financial
statements before investing in that company. These are the focus of this study.
1.3
Objectives of the Study
On noting that most
investments made by firms end in failure, it is the overall objective of this
study to determine how firms can use
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financial statement analysis and interpretation to aid
management decisions. Specifically, the study is designed to:
i) Find
out how the use of financial statement analysis assists organizations in
identifying investment opportunities.
ii) Find
out how increasing investment returns can be achieved using financial statement
analysis.
iii) Find
out the extent to which a company’s overall profitability can be hampered if it
does not analyse another company’s financial statement before investing in it.
iv) Find
out how business failures can be curbed or minimized and corporate objective
achieved through successful investment.
v)
Identify
alternative ways of minimizing investment risk.
1.4
Research Questions
The following questions are
put forward for the purpose of the study.
1) Is
financial statement analysis important/necessary in every organization?
2)
Who
are the users of financial statement?
3) How
can a financial statement of an organization be interpreted?
4) How
can its interpretation be used in making effective management decisions?
1.5
Hypotheses of the Study
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To identify the achievement of the
desired objectives, the following hypothesis are formulated:
HO: Represents Null hypothesis
HI: Represents Alternative
hypothesis
Research
hypothesis No 1
HO:
There is no significant difference between the returns of a financial statement
analysis and interpretation based on management decisions.
H1:
There is a significant difference between the returns of a financial statement
analysis and interpretation based on management decisions.
Research
hypothesis No 2
HO:
There is no significant relationship between a firms profitability an financial
statement analysis and interpretation based management decisions.
HI:
There is a significant relationship between a firms profitability and financial
statement analysis and integration based management decision.
1.6
Significance of the Study
The study of the use of
financial statement analysis and interpretation in management decision is meant
to contribute immensely to sustained business operations in selected firms
south south region and general growth in business, be it private or public. The
study shall be beneficial in the following ways:
i) It will redirect management on the need
for the use of financial statement analysis and interpretation of rational
investment decision.
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ii) It
will inform management on the possible and available investment ratio, their
functions and uses for a greater evaluation of a company’s capabilities and
profitability.
iii) The
work will also serve as a reference material to other persons who will conduct studies
in similar areas both within and outside the university.
1.7 Scope of the Study
The study is conducted to
cover selected firms both in South-South region.
However, this study is
conducted to cover the use of financial statement which includes; (Balance
sheet, income statement, statement of cash flow and statement of retained
earnings) analysis civil interpretation management decision.
1.8
Limitation of the Study
The research work has some
limitations due to some problems encountered from the sources of collecting
useful materials also some unforeseen circumstances which posted as a threat
during preparation of this research project includes:
-
TIME: A research of this kind would require
enough time to cover many areas of activity effectively, but since the
researcher is a student with other classroom works to do, the time allocated
for the study was limited.
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-
FINANCE: During the course of this research,
another stumbling block. Judgment financial resources was encountered. The
researcher has to make due with little financial provision available to achieve
a qualitative and acceptable research finding.
-
Health was also a limiting factor, for
instance, the researcher falling ill in the cause of the study, which stopped
the research for some time.
-
TRANSPORATION: The source of collecting
useful material or information is far and the transport logistics expensive, in
some cases, the journey was fruitless if the staff was not available.
1.9
Definition of Terms
*
RATIOS: A ratio is the relationship between
two amounts that results from dividing one by the other. It is an accounting
term used to describe the financial index which compares two financial
variables such as current assets and current liabilities.
Examples
of ratios are quick ratio, and test etc.
*
ACCOUNTING RATIOS: “they are the relationship
between figures expressed as ratios”
*
INVESTMENT DECISIONS: This relates to
allocation of capital and involves decisions to commit funds to long term
assets, which will yield benefits in future.
*
RATIO ANALYSIS:
It
is an analytical tool designed to identify significant relationships between
two financial statement amounts.
*
SECURITY: Security is a financial asset which
earns a fixed and/or variable periodic income till terminal maturity period if
any.
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