CHAPTER ONE
INTRODUCTION
Financial
Statement Analysis is a method of reviewing and analyzing a company’s
accounting reports (financial statements) in order to gauge its past, present
or projected future performance. This process of reviewing the financial
statements allows for better economic decision making.
Globally,
publicly listed companies are required by law to file their financial
statements with the relevant authorities. For example, publicly listed firms in
America are required to submit their financial statements to the Securities and
Exchange Commission (SEC). Firms are also obligated to provide their financial
statements in the annual report that they share with their stakeholders. As
financial statements are prepared in order to meet requirements, the second
step in the process is to analyze them effectively so that future profitability
and cash flows canbe forecasted.Therefore, the main purpose of financial
statement analysis is to utilize information about the past performance of the
company in order to predict how it will fare in the future. Another important
purpose of the analysis of financial statements is to identify potential
problem areas and troubleshoot those problems.
There
are different users of financial statement analysis. These can be classified
into internal and external users. Internal users refer to the management of the
company who analyzes financial statements in order to make decisions related to
the operations of the company. On the other hand, external users do not
necessarily belong to the company but still hold some sort of financial
interest. These include owners, investors, creditors, government, employees,
customers, and the general public.The managers of the company use their
financial statement analysis to make intelligent decisions about their
performance. For instance, they may determine cost per distribution channel, or
how much cash they have left, from their accounting reports and make decisions
from these analysis results.
Small
business owners need financial information from their operations to determine
whether the business is profitable. It helps in making decisions like whether
to continue operating the business, whether to improve business strategies or
whether to give up on the business altogether.
People
who have purchased stock or shares in a company need financial information to
analyze the way the company is performing. They use financial statement
analysis to determine what to do with their investments in the company. So
depending on how the company is doing, they will either hold onto their stock,
sell it or buy more.
Creditors
are interested in knowing if a company will be able to honor its payments as
they become due. They use cash flow analysis of the company’s accounting
records to measure the company’s liquidity, or its ability to make short-term
payments.
Governing
and regulating bodies of the state look at financial statement analysis to
determine how the economy is performing in general so they can plan their
financial and industrial policies. Tax authorities also analyze a company’s
statements to calculate the tax burden that the company has to pay. Employees
need to know if their employment is secure and if there is a possibility of a
pay raise. They want to be abreast of their company’s profitability and
stability. Employees may also be interested in knowing the company’s financial
position to see whether there may be plans for expansion and hence, career
prospects for them. Customers need to know about the ability of the company to
service its clients into the future. The need to know about the company’s
stability of operations is heightened if the customer (i.e. a distributor or
procurer of specialized products) is dependent wholly on the company for its
supplies.
Anyone in the general public, like students, analysts and researchers, may be interested in using a company’s financial statement analysis. They may wish to evaluate the effects of the firm on the environment, or the economy or even the local community. For instance, if the company is running corporate social responsibility programs for improving the community, the public may want to be aware of the future operations of the company.
Analysis of financial statement is meant to be comprehensive and relevant just to mention a few. To ensure that this is the case, there are two methods of financial analysis; the horizontal analysis, vertical analysis trend analysis, ratio analysis.
Manufacturing companies have a nature that requires a great deal of record keeping based on accounting principles and the ever changing accounting standards. It is clear that proper analyses of financial statement are important in any organization. Nevertheless, one can not dispute the fact that with each method of analysis there is an underlying factor that hinders the comparability of records.Thus, the problem at hand is the scheme of window dressing which an investor has to be on the lookout for If he wants to make a good investment decision. Window dressing is referred to as cosmetic financial reporting or creative accounting. It is a situation whereby the financial statements are reported to deliberately or intentionally falsify the accounts with the aim of overstating the performance of a business. This could mislead a potential investor into a non profitable investment decision. Proper financial analysis will open the eye of not just the investor but also other users of such information. They will be able to detect the loopholes and see a misleading financial statement for what it is.
This
study aims at explaining the effects of financial statement analysis on
investment decision making in manufacturing industries. With that being said,
it is befitting to say that anything outside from a proper financial statement
is a problem to investors and users of accounting information. Thus window
dressing aims at destroying the essence of a proper financial statement,
thereby making room for unprofitable or unfavorable investment decision making.
The broad objective of
his study is to analyze the effect of financial analysis on investment
decision.
Specific objectives are to;
EFFECT OF FINANCIAL ANALYSIS ON INVESTMENT DECISION IN A MANUFACTURING COMPANY
