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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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