ANALYSIS AND INTERPRETATION OF FINANCIAL STATEMENT AS A MANAGERIAL TOOL FOR
DECISION MAKING
Abstract
Financial Statement Analysis and Interpretation is a very vital instrument of good management decision-making in business enterprise. Good decisions ensure business survival, profitability and growth. Without financial statement analysis in investment decisions, an enterprise is likely to make decisions, which could spell its doom. Poor or lack of qualitative financial statement analysis could lead to investment returns, low profitability and even inability to identify viable investment opportunities. The main objective of this project is therefore, was to determine how firms could use financial statement analysis and interpretation to aid management decisions and to avert the problems highlighted above. Primary and secondary data are employed to broaden the scope of this study. Primary data are sourced from questionnaire responses. This provided data for the validation of the hypotheses tested with the use of chi-square (X2). The test revealed as follows: (1) Significant difference between the returns of the financial statement in Analysis and Interpretation based on management decision. (2) Organizational profitability has relationship with financial statement analysis and interpretation based management decision but not significantly. The project concludes that companies should pay great attention to the use of financial statement analysis so as to properly equip themselves with this invaluable tool. The researcher recommends the following: (a) Accountants or financial analysts should not be rushed in collection, preparation, analysis and interpretation off financial statements. (b) Financial statements should be made to reflect current cost accounting to eliminate or reduce the effects to historical cost principle and inflation risk element. (c) A combination of different ratios should be used in analyzing a company’s financial and/or operating performance. Proper use of financial statement analysis should be made not only in investment but also in other areas of decision making.
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TABLE OF CONTENT
Title page – – – – – – – — – i
Approval page – – – – – – – – ii
Dedication – – – – – – – – – iii
Acknowledgement – – – – – – – iv
Abstract – – – – – – – – – v
Table of content – – – – – – – – vi
Chapter One: INTRODUCTION
1.1 Background of the Study – – – – – 1
1.2 Statement of Problem – – – – – – 4
1.3 Objectives of the Study- – – – – – 4
1.4 Research Questions – – – – – – 5
1.5 Hypotheses of the Study – – – – – 6
1.6 Significance of the Study – – – – – 6
1.7 Scope of the Study – – – – – – 7
1.8 Limitation of the Study – – – – – – 7
1.9 Definition of Terms – – – – – – 8
References – – – – – – – – 10
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Chapter Two: LITERATURE REVIEW
2.1 Introduction – – – – – – 11
2.2 What is Financial Statement?- – – – 12
2.2.1 Objective of a Financial Statement Analysis – 13
2.3 Uses and Users of Financial Statement – – 14
2.4 Classification of Financial Statement – – 15
2.5 Relationship among the Statement of Financial
Position, Income Statement, Statement of cash
Flows and Statement of Retained Earnings – 18
2.6 Techniques and financial Statement Analysis and
Interpretation – – – – – – 19
2.6.1 Horizontal Analysis – – – – – 19
2.6.2 Trend Analysis – – – – – – 20
2.6.3 Vertical Analysis – – – – – – 24
2.6.4 Ratio Analysis – – – – – – 24
2.7 Definition of Ratio – – – – – 24
2.8 Types and Classification — – – – 26
2.8.1Liquidity Ratios – – – – – – 27
2.8.2 Leverage Ratios – – – – – – 30
2.8.3 Activity Ratios – – – – – – 32
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2.8.4 Profitability Ratios – – – – – 34
2.9 Nature of Accounting Ratios – — – – 37
2.10 Uses of Ratio in Analyzing Financial Statement 39
2.11 Limitations of Financial Statement Analysis – 40
2.12 Use of Different Accounting Principles – – 40
2.13 Industry Affiliation – – – – – 41
2.14 Accounting Differences Between Countries – 42
2.15 The Impact of Inflation of Financial Statement
Analysis – – – – – – – – 42
2.16 Features of a Good Management Decision
Technique – – – – – – – 44
2.17 Environment of Management Decision Making – 45
References – – – – – — – 47
Chapter Three
3.1 Research Design – – – – – – 4
3.2 Sources and Method of Data Collection — – 48
3.3 Research Instrument – – – – – 49
3.4 Reliability/Validity of Research Instrument – 49
3.5 Population – – – – — – – 50
3.6 Sample size and Technique – – – – 50
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3.7 Administration of Research Instrument – – 53
3.8 Method of Data Analysis – – – – 53
3.9 Decision Criteria for Validation of Hypothesis – 56
References – – – – – – — 57
Chapter Four: DATA PRESENTATION AND ANALYSIS -58
4.1 Data Presentation – – – – – 60
4.2 Analysis of Question – – – – – 61
4.3 Test of Hypothesis – – – – – 71
Chapter Five: SUMMARY OF FINDINGS, CONCLUSION AND
RECOMMENDATIONS
5.1 Summary of Findings – – – – – 76
5.2 Conclusion – – – – – – – 77
5.3 Recommendations – – – – – 77
Bibliography – — – – – – 79
Appendix – – — – – – – – 80
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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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1.2 Statement of the Problem
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 id 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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