FINANCIAL RATIOS AND COMPANY PERFORMANCES
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FINANCIAL RATIOS AND COMPANY PERFORMANCES
Chapter one
INTRODUCTION
1.1 Background for the Study
Financial information is a critical component in both internal and external decision-making. As a result, any organisation (profit or non-profit) that sources and uses funds must prepare a statement of account that includes a detailed analysis of the movement of funds inside the organisation during a specific time period.
This information is normally provided in the firm’s financial statements (profit/loss account and balance sheet), which represent the true situation of the firm as of a specific date and will help all relevant stakeholders gain insight into the firm’s operation and performance.
One of the accountant’s primary goals is to provide financial information to the user in a format that allows for decision-making. The financial statements provide the foundation for the majority of financial management terminology.
A firm’s financial statements include three primary accounts. The balance sheet, profit and loss account, and cash flow statement. A balance sheet depicts a company’s financial situation and accounting value as of a specific date.
As a snapshot of the firm, it is a practical way of organising and summarising what a firm owns (its assets), owes (its obligations), and the difference between the two (its equity) at any particular time. The profit and loss account illustrates the results of this firm’s operations over a specific accounting period.
The cash flow statement details cash inflows and outflows over an accounting period and categorises cash flows into operating, investing, and financing activities. This statement is typically included in a financial statement to provide additional information that will assist stakeholders in understanding the financial statements.
The balance sheet and profit and loss account are the two primary financial components that we use to analyse and evaluate financial information for every commercial organisation.
Financial analysis is the process of discovering a company’s financial strengths and weaknesses by appropriately creating links between balance-sheet items and profit and loss statements.
Financial analysis can be performed by the firm’s management or by third parties such as owners, creditors, investors, and others (Foster, 1986). Ratios are an important instrument in financial analysis.
Financial ratios are the relationships between two or more financial data points, typically expressed as a percentage or in relation to another figure or collection of numbers in the same financial statement.
These ratios are tools for analysing and investigating the links between various types of financial data. It also serves as a standard for assessing a company’s financial status and performance.
Absolute accounting figures reported in financial statements do not provide a meaningful understanding of a firm’s performance and financial position; such information only conveys meaning when quantitatively compared and related to other relevant information using ratio analysis.
The procedures are based on tried-and-true accounting ratios that have been around for much longer. Benjamin Graham, often regarded as the father of fundamental analysis, popularised financial ratio analysis theory.
Warren Buffett’s mentor and teacher was Benjamin Graham, who was a professor at Columbia Business School and a very successful investor in his own right beginning in 1928.
Fundamental analysis, of which financial ratio analysis is a subset, considers a company’s financial statements, management, health, and competitive position when determining a share price valuation.
It differs from the other generally used types of investment analysis – quantitative analysis and technical analysis – in that it looks from the bottom up rather than from the top down, or, in the case of technical analysis, from what the charts say.
A company’s performance is often evaluated based on how successfully it uses its assets, shareholder equity and liability, income, and expenses. Financial ratio analysis is one of the most effective performance measurement tools for any organisation. In order to determine the firm’s financial status.
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