APPLICATION OF RATIO ANALYSIS TO BUSINESS ORGANISATIONS
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APPLICATION OF RATIO ANALYSIS TO BUSINESS ORGANISATIONS
Chapter one
INTRODUCTION
1.1 Background of the Study
Every firm has two fundamental objectives: profitability and solvency. Profitability refers to a company’s ability to generate profits, whereas solvency refers to its ability to pay obligations as they become due. (Hermanson et al. 1992).
However, achieving these goals necessitates effective management of corporate resources through planning, budgeting, forecasting, control, and decision-making.
Additionally, the business’s strengths and weaknesses must be identified and corrective steps implemented. Surprisingly, accounting provides information that aids these duties.
Accounting measures and communicates economic information required for decision-making. Thus, the American Accounting Association defined accounting as “the process of identifying, measuring, and communicating economic information to permit informed judgements and decisions by the information” (Okezie, 2002).
The income statement reveals a company’s profitability or operational results, whereas the balance sheet shows its solvency or financial condition.
Although earnings are frequently used to evaluate a company’s performance, they must be linked to the various elements on the financial statements in order to be meaningful and useful for decision making.
Furthermore, due to the summarised form of financial accounts, many truths are obscured. Thus, they must be analysed and evaluated using financial ratios so that users may comprehend the meaning of the absolute amounts provided and make informed business decisions.
In this context, Essien (2006) discovered that financial statements include a wealth of financial information that is concealed inside the data. Figures in financial accounts are more informative when they are linked to one another or to other pertinent financial data.
As a result, users of financial information go one step farther and build correlations (or ratios) between selected data in financial statements.
Igben (1999) defines an accounting or financial ratio as “a proportion, fraction, or percentage that expresses the relationship between one item in a set of financial statements and another item in the financial statements.”
Accounting ratios are the most effective instruments for analysing and evaluating financial accounts.” As a result, ratio analysis is extracting numerical (or item) statistics from financial statements and converting them into ratios in order to make more informed judgements and decisions (Lasher 1997).
MCShane et al. (2000) define decision-making as “a conscious process of making choices among one or more alternatives with the intention of moving towards some desired state of affairs.”
As a result, business decisions can be described as choices regarding the allocation and/or use of corporate resources to achieve business objectives.
In order to make a decision, information is required. Bittel et al. (1984:340) noticed that managers desire information because they need to make decisions. The proper utilisation of information is an essential component of decision-making. Remarkably, ratio analysis is one of the most effective techniques of giving information for decision-making.
Financial ratios are required to appropriately make business decisions such as make or acquire, invest or divest, expand or contract, capital organisation and reconstruction, and so on. They include information on a company’s financial strengths and shortcomings, as well as areas that need to be investigated further.
As a result, this study demonstrates how ratio analysis can assist managers, owners, investors, creditors, and other stakeholders in making informed judgements and decisions regarding a company’s previous performance, current state, and future potential.
1.2 Statement of Problems
Financial information contained in financial statements is useful in making business choices; however, it should be recognised that financial statements are a means to an end in themselves. Thus, the use of financial statements in decision-making is not always easy due to the following issues:
Given the summarised nature of the information contained in financial statements, they must be examined and interpreted using financial ratios in order for management and stakeholders to understand them and make informed business decisions.
Many consumers of financial statements are unfamiliar with accounting ratios and how they might be used to financial statements to improve decision making.
Despite the enormous benefits of ratio analysis, there are numerous drawbacks or limitations to its use.
In light of the aforementioned issues, this study is being conducted to determine the right application of financial ratios and the roles ratio analysis plays in business decision making.
1.3 PURPOSE OF THE STUDY
The purpose of this research, taking into account the challenges listed above, includes:
(i) To demonstrate how ratio analysis supports the accurate interpretation of information presented in financial statements.
(ii) To demonstrate how ratio analysis facilitates business decisions.
(iii) To investigate the strategies used to analyse financial accounts.
(iv) Determine the value of financial ratios in measuring and forecasting a company’s performance and financial status.
(v) To identify the barriers to the proper application of financial ratios in company decisions.
(vi) To offer techniques to make better use of ratio analysis in decision making.
1.4 RESEARCH QUESTIONS.
i.) Is ratio analysis beneficial for analysing and predicting corporate performance, as well as identifying opportunities for improvement?
ii) Does Ratio Analysis aid in the accurate interpretation of information included in financial statements?
iii) Is ratio analysis relevant to management, investors, owners, and creditors in their respective business units?
iv) Are there any difficulties to using ratio analysis properly in business decisions?
1.5 Research Hypothesis
To draw a reliable inference about the population based on the samples that will be collected, the following hypotheses are formulated:
Hypothesis
HO: Ratio analysis cannot be utilised to make decisions within an organisation.
H1: Ratio analysis can be utilised for organisational decision-making.
1.6. IMPORTANCE OF THE STUDY.
A bank’s primary role as a custodian and creator of money, as well as a financier of commercial enterprises and economic activity, necessitates that everyone maintain its survival.
This study is important for the following reasons:
(a) The study will be a useful tool for predicting business failure.
(b) It will assist the business analyst in evaluating the capital structure and making appropriate investment decisions and recommendations.
(c)It will be an important tool for industry managers to effectively utilise shareholder equity and debenture stock.
(d)It is hoped that the research findings will aid in making optimal business decisions when the suggestions are followed.
1.7. SCOPE AND LIMITATION OF THE STUDY.
The application of ratio analysis to business organisations can be quite broad, depending on how the analyst examines it; nevertheless, for the purposes of this project, this study will be limited to Access Bank Plc.
1.8. Definition of Terms
Accounting is the process of recording, summarising, analysing, and interpreting financial (money-related) actions so that individuals and organisations can make educated judgements and decisions.
A balance sheet is a financial statement that shows an organization’s financial status by including assets, liabilities, and owner equity capital at a specific date or at the end of a specific period.
BUSINESS DECISION: Decisions made regarding the allocation and/or use of business resources for producing, purchasing, selling, or supplying goods or services for a profit.
BUSINESS: An activity, enterprise, or organisation formed to offer goods and services for profit in order to meet human needs.
DECISION MAKING: A mental process in which an individual or group of people acquire information and choose between two or more possible courses of action.
FINANCIAL RATIO: A proportion, fraction, or percentage that expresses the relationship between one item in financial statements and another in the same financial statements.
FINANCIAL STATEMENT: Quantitative information about an organization’s economic activities created to indicate the entity’s results and financial condition, which is frequently given in the form of a Balance Sheet, Income Statement, Funds Flow Statement, etc.
INCOME STATEMENT: A financial statement, also known as a trading or profit and loss account, that compares revenues and expenses to illustrate an enterprise’s profitability or operational outcomes over a given time period, such as a month or year.
RATIO ANALYSIS: A systematic study of accounting data to establish correlations between various statistics on financial statements that bring together the results of a business’s activities.
Ratio is a fractional relationship between two numbers.
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