1
THE ROLE OF RATIO ANALYSIS IN BUSINESS DECISIONS A
CASE STUDY OF O. JACO BROS. ENT. (NIG.) LTD., ABA, ABIA
STATE
BY
ILORAH FABIAN UZOCHUKWU
ACC/2006/247
A RESEARCH PROJECT
SUBMITTED TO
DEPARTMENT OF ACCOUNTING
FACULTY OF MANAGEMENT AND SOCIAL SCIENCE
CARITAS UNIVERSITY AMOJI – NIKE
EMENE – ENUGU
AUGUST, 2010
2
TITLE PAGE
THE ROLE OF RATIO ANALYSIS IN BUSINESS DECISIONS A
CASE STUDY OF O. JACO BROS. ENT. (NIG.) LTD., ABA, ABIA
STATE
BY
ILORAH FABIAN UZOCHUKWU
ACC/2006/247
A RESEARCH PROJECT
SUBMITTED TO
DEPARTMENT OF ACCOUNTING
FACULTY OF MANAGEMENT AND SOCIAL SCIENCE
CARITAS UNIVERSITY AMOJI – NIKE
EMENE – ENUGU
IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR
THE AWARD OF A BACHELOR OF SCIENCE (B.SC.) DEGREE
IN ACCOUNTING
AUGUST, 2010
3
DEDICATION
To the most high God and Universal Sovereign, Almighty.
The source of life, giver of wisdom and source of knowledge.
To my parent Chief C.U Ilorah, late Miss Caroline Ilorah
(people that brought me into this lively world), my elder brothers
and sisters for they are the backbone behind this research
conclusion through their financial support and to sponsor my
education up till this level.
To all my friends and well wishers that has been playing for
me and advising me to keep studying those that gave mw the
right information on where to obtain relevant materials to write
up this project.
4
CERTIFICATION
This is to certify that the research work on “The role of Ratio
Analysis in business decisions: A case study of O. Jaco Bros.
Ent. (Nig). Ltd., Aba, Abia State”. Was carried out by ILORAH
FABIAN UZOCHUKWU with registration number Acc/2006/247
of the Department of Accountancy, Caritas University, Amorji
Nike, Enugu State.
Was examined and found it acceptable for the award of
bachelor of science (Bsc). Degree in Accountancy.
…………………………..
Mr Agu I.C.
…………………………….
Data
(Supervisor)
……………………………
C.I Ugwu
………………………………
Date
(HOD)
……………………………
External Examiner
……………………………..
Date
5
ACKNOWLEDGEMENT
I am indeed thankful to the entire lecturers in the
Department of Accounting, Caritas University. For all knowledge
that was imparked on me by them. Lecturers like Mr. Agu I.C.
(My supervisor) for his best effort that he put to supervise this
research and ensure that it was written to the peak. Mr. Ugwu
C.C. (HOD). Mr. Ovute Frank, Mr. Nsoke P.U., Dr. Miss Sabina
Eyisi, Enekwe C. I., am grateful to you all.
I won’t forget to thanks the D.V.C of the university Rev. Fr.
Remi Onyewunyi for all the advice he has been giving like a
father to us (the students) when celebrating mass to always
remain a good student.
Finally, he all my friends and well wishers due to fact of
spare I can’t be able to mention names.
6
TABLE OF CONTENTS
Title Page
i
Dedication
ii
Certification
iii
Acknowledgements
iv
Table of Contents
v
Abstract
vi
CHAPTER ONE
INTRODUCTION
1.1
Background Information
1
1.2
Statement of Problem
2
1.3
Objectives of the Study
5
1.4
Research Question
6
1.5
Significance of the Study
6
1.6
Scope of the Study
7
1.7
Limitation of Study
8
1.8
Definition of Terms used in the Study
9
1.9
Brief Historical Background of O. Jaco Bros.
Ent. (Nig.) Ltd, Aba, Abia State.
Reference
CHAPTER TWO
11
13
7
REVIEW OF RELATED LITERATURE
2.1
Introduction
15
2.2
Financial Statement Analysis
15
2.3
Parties Interested in Financial Statement Analysis
16
2.4
Objectives of Financial Statement analysis
17
2.5
Sources of Information for financial
Statement Analysis
2.6
18
Tools and Techniques of Financial
Statement Analysis
19
2.7
Uses and Objectives of Ratio Analysis
28
2.8
Types of Ratio Analysis
29
2.8.1 Univariate Ratio Analysis
29
2.8.2 Multivariate Ratio Analysis
62
2.9
67
Limitations of Ratio Analysis
Reference
71
CHAPTER THREE
RESEARCH METHODOLOGY
3.1
Introduction
72
3.2
Research Design
72
3.3
Data Collection Technique
72
3.4
Population
73
8
3.5
Sample Size and Sampling Technique
74
3.6
Instrument for Data Collection
75
3.7
Questionnaires Administration
75
Reference
76
CHAPTER FOUR
PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA
4.1
Introduction
77
4.2
Data presentation and Analysis
77
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1
Introduction
86
5.2
Summary and Discussion of Findings
86
5.3
Recommendations
88
5.4
Conclusion
89
Reference
91
BIBLIOGRAPHY
91
APPENDICES
Appendix 1
Research Questionnaire to the
Management and Staff of O. Jaco Bros. Ent.
(Nig.) Ltd., Aba.
94
9
ABSTRACT
Accounting information provided by means of financial
statements- The income statement and the Balance Sheet are
often in summarized form.
Viewed on the surface, the truths
about the results and the financial position of a business hidden
in them remain veiled.
To be of optimal benefit and as well
enable the users make well – informed decisions, financial
statements need to be analyzed by means of ratios. Therefore, in
order to establish the role of ratio analysis in business decisions,
this research is carried out, using O. Jaco Bros. Ent. (Nig.) LTD.,
Aba Abia State as the Case study. The researcher made use of
both primary and secondary sources of data collection. However,
for the former, questionnaires were administered, whereas for the
later, relevant were received. The data Collected via the primary
data
sources
were
analyzed
using
simple
averages
and
percentages. After ratios analysis conducted on the chapter four,
mode at 95 level of confidence (5% level of significance). Finally,
it was established that ratios analysis evils business decision.
10
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND INFORMATION
The
two
primary
objectives
of
every
business
are
profitability and solvency. Profitability is the ability of a business
to make profit, while solvency is the ability of a business to pay
debts as they come due.
(Hermanson et al, 1992: 824).
However, the achievement of these objectives requires efficient
management of resources of the business through planning,
budgeting, forecasting, control, and decision – making. Also, the
strengths and weakness of the business need to be identified and
necessary corrective measures applied. Interestingly, accounting
provides information that facilitates these functions.
Basically,
accounting
measures
and
communicates
economic information needed for decision –making.
Thus, the
American Accounting Association (in Okezie, 2002:1) defined
accounting as “the process of identifying, measuring and
communicating
economic
information
to
permit
informed
judgments and decisions by the information”. Statement and the
Balance Sheet. The Income Statement shows the profitability or
11
profitability or operational result of a business, while the balance
sheet shows the solvency or financial position of a business.
Although profiles are often used as the basis for judging the
performance of a business, such profits must be related to the
various items of the financial statements in order to be
meaningful and useful for decision making. Furthermore, owing
to the summarized nature of financial statements, a lot of truths
are hidden in them. Thus, they need to the analyzed and
interpreted by means of financial ratios to enable the users
understand the meaning of the absolute amounts shown in
them, and make informed business decisions.
In this regard, Essien (2006:144) observed:
Financial statements carry lots of financial Information that
are
hidden
in
the
figures.
The
figures
in
financial
statements become more useful when they are related to
each other or to some other relevant financial data.
Therefore, users of financial information go a further step to
establish relationships (or ratios) among selected data in
financial statements.
According to Igben (1999:423), “Accounting {or financial}
ratio is a proportion or fraction or percentage expressing the
12
relationship between one item in a set financial statements and
another item in the financial statements. Accounting ratios are
the most powerful of all tools used in analyzed and interpreting
financial statements”. Therefore, ratio analysis involves taking
stats of number (or items) out of financial statements and
forming ratios with them, to enhance informed judgments and
decisions (Lasher, 1997:66).
MCShane et al. (2000:336) defined decision-making as “a
conscious process of making choices among one or more
alternatives with the interior of moving toward some desired state
of affairs.” Therefore, business decisions can be defined as
choices relating to the allocation and/or use of business
resources to achieve business goals.
Decision-making calls information. Bittel et al. (1984:340)
observed: “Managers want information because they need to
make decisions. The proper use of information is an important
part of decision-making.” Remarkably, one of the effective ways of
providing information needed for decision-making is ratio
analysis.
Yes, business dictions of make or buy, investment or
divestment, expansion or contration, capital-organization and
13
reconstruction, and so on cannot be properly made without the
aid of financial ratios. They give cue to the financial strengths
and weaknesses of a business, and highlight aspects of a
business requiring further investigation.
Therefore, this research is carried out to show ratio analysis
help managers, shareholders, investors, creditors, and other
stakeholders make informed judgments and decisions about the
past performance, present condition, and futures potential of a
business.
1.2 STATEMENT OF PROBLEM
Financial information provided in financial statements are
useful in business decisions. However, it must be noted that
financial statements are means to an and not an end in
themselves. Thus the use of financial statements in decisionmaking is not always easy owing to the following problems:
1.
In view of the summarized nature of the information
contained in financial statements, they need to be analyzed
and interpreted by means of financial ratios to enable
management and stakeholders understand them and make
well-informed business decisions.
14
2.
Many users of financial statements are not knowledgeable
about accounting ratios and how the ratios can be applied
to financial statements to aid decision-making.
3.
Despite the immense benefits of ratio analysis, there are a
lot of weaknesses or limitations associated with its use.
In view of the above stated problems, this research is
embarked upon to identify the proper use of financial ratios,
and the roles ratio analysis plays in business decisions.
1.3 OBJECTIVES OF THE STUDY
In consideration of the problems identified above, the
objective of this research include.
1.
To show how ratio analysis facilitates proper understanding
of information contained in financial statements.
2.
To show how ratio analysis aids business decisions.
3.
To examine the techniques used in analysis financial
statements.
4.
To identify the usefulness of financial ratios in measuring
and predicting the performance and financial position of a
business.
5.
To unravel the obstacles to the proper use of financial ratios
in business decisions.
15
6.
To suggest on ways to enhance efficient use of ratio analysis
in decision-making.
1.4 RESEARCH QUESTIONS
i.
Is ratio analysis useful in evaluating and prediction the
performance of a business as well as intensifying areas that
regret improvement?
ii.
Do you agree with the fact that ratio analysis facilitates
proper understanding of information contained in financial
statements?
iii.
Is
ratio
analysis
useful
to
management
investors,
shareholders and creditors in their business divisions?
iv.
Does financial ratio helps to unravel the mass of truth
hidden in financial statements?
v.
Are there obstacles that affect the proper use of ratio
analysis in business decisions?
1.5 SIGNIFICANCE OF THE STUDY
The significance of this study is that on its completion, the
following benefits will be derived:
1.
The study will help management of O. Jaco Brros. Ent.
(Nig.) Ltd, Aba and others to know how ratio analysis can
16
help them understand the financial contained in financial
statements and enhance their business decisions.
2.
The findings of the research and the supportive reference
materials will be of immense help to students in tertiary
institutions and other researchers to investigate further in
the area of study.
3.
It is hoped that the result of the research will facilitate
optimal business decisions when the recommendations are
complied with.
4.
The
study
managers,
will
and
encourage
government
businessmen,
authorities
to
investors,
appreciate
quantitative techniques like financial ratios when making
economic and business decisions.
1.6 SCOPE OF THE STUDY
According to Akpakpan (2005:7), “scope of the study is the
limits or boundary lines of the study. It is the areas covered by
the research or the extent the researchers would go. Limitations
of the study are hindrances or obstacles witnessed by the
researcher in the course of the study. Which could influence his
conclusions.”
17
In
view of the impossibility of covering every type of
financial statement, this study is therefore restricted to the
analysis of the income statement and the Balance Sheet by
means of financial ratios. However, other analytical techniques
such as horizontal analysis, vertical analysis and termed analysis
would also be explained and illustrated.
Finally, although University Ratio Analysis is the core of the
study, nevertheless, multivariate Ratio Analysis would be partly
illustrated using Du pont Equations.
1.7 LIMITATION OF STUDY
In the course of this research work, the researcher was
faced with some constraints which plaved a limit he the ability
and performance of the researcher encountered the following
constraints among others.
1.
Insufficient Financial:
The researcher needed a lot of
money to travel as far as Aba to collect the necessary data from
the firm under syudy. Money was also required to vist secondary
data sources such as the internet, libraries, professional bodies,
and so on.
2.
Lack of Co-Operation:
The unco-operative attitudes of
many employees of the firm under study were not encouraging.
18
Some of them were so biased and prejudiced that did not care to
understand the purpose of the research. This resulted to their
failure to provide sufficient information required for proper
completion of the study.
3.
Time Pressure:
Time allowed was not enough for
through completion of the research, in consideration of the fact
the we were also facing other academic studies during the
semester.
1.8 DEFINITION OF TERMS USED IN THE STUDY
Accounting:
The process of recording, summarizing, analysis
and interpreting financial (money-related) activities to permit
individuals and organizations to make informed judgments and
decisions. (Dansby et al., 2000: 1033).
Balance Sheet:
A financial statement containing assets,
liabilities, and owner’s equity or capital at a particular data or at
the end of a particular period, to show the financial position of a
organization. (Akpakpan, 2002:106).
Business:
An activity, enterprise or organization established
to provide goods and services at a profit, in order to satisfy
human wants. (Ikon,2004:2).
19
Business Decision: Choices made on matters relating to the
allocation and/or use of business resources for making, buying,
selling, or supplying goods or services at a profit.
Decision-Making:
A mental process by which an individual or
group of individuals gather data and make a choice between two
or more alternative courses action. (Ayandele, 2005:3).
Financial Ratio:
A
proportion,
fraction,
or
percentage
expressing the relationship between one item ion sett of financial
statements and another item in the same financial statements.
(Igben, 1999:423).
Financial Statement:
Quantitative information on the
economic activities of an organization prepared to show the
result and the financial position of the entity, often presented in
terms
of
Balance
Sheet,
Income
Statement,
Funds
flow
statement, and so on.
Income Statement: A financial statement often referred to as
the trading and profit loss account, matching revenues against
expense to show the profitability or operational results of an
enterprise over a period of time, such as a month or year.
(Hermanson et al. 1992:25).
20
Ratio:
A fractional relationship of one number (or itme) to
another. (Dansby et al. 2000:1047).
Ratio Analysis:
A systematic review of accounting data by
establishing relationships among various figures on the financial
statements which bring together the results of the activities a
business. (Omuya, 1983:430).
Role:
The degree to which somebody or something is
involved in a situation or an actively and the effect that they have
on it. (Hornby et al.2000:1021).
1.9 BRIFF HISTORICAL BACKGROUND OF O. JACO BROS.
ENT. (NIG). LTD. ABA STATE
O. Jaco Bros. Ent. (Nig) Ltd, Aba, Abia Sate was established
in 1982. It started as a sole proprietorship business owned,
runned, and managed by Nze Josephat Okolocha.
The firm is a trading concern. It specialized in sale,
marketing, and distribution of various kinds of motorcycles,
spare parts, and electric generators.
Meanwhile, in line with outstanding growth witnessed by
the firm in the last couple of years, the organization is now an
incorporated private limited liability company since 1999.
21
At present, the company has a total asset base of over N50
million and employs more than 30 workers. It has 6 branches. 4
in Aba, 1 in port Harcourt, and in Ekwulobia (Anambra State).
The head office located at
59, Jubilee Road, Aba, Abia
State, (which is the center focus of this study), has 4
departments:
the
sales
and
marketing
department,
the
purchasing and supply department, the Administration and
personnel
department,
Department.
and
the
finance
and
Accounts
22
REFERENCE
Akpakpan, Bassey A. (2000). Accounting for Beginners: An
Introduction
to
Financial
Accounting.
Part
1.
(2005).
Guideline on Project Writing: Introducing Students
to
Research Through Practical Approach. Revised ed. Uyo:
Abaam Publishing Co.
Ayandele, I. A. (2005) Quantitative Techniques for Managerial
Decision. Uyo: Cle-Print Publishers.
Bittel, Lester R., Ronald S. Burke & Lawrence R. Lafarge. (1984).
An Introduction to Business in Action. 2nd ed. New York:
McGraw Hill Book Company.
Dansby, Robert L., Burton S. Kaliski & Michael D. Lawrence.
(2000). Paradigm College Accounting. 4th ed. St Paul, MN:
Paradigm Publishing Inc.
Essien, enefiok
E.
(2006)
Entrepreneurship:
Concept
and
Practice. Uyo: Abaam Publishing Co.
Hermanson, Roger H., James Don Edwared & Michael W. Maher.
(1992). Accounting Principles. 5th ed. Boston, MA: Richard D.
Irwin, Inc.
Hornby, A. S., et al.. (2000). Oxford Advanced Learner’s
Dictionary. 6th ed. Oxford: Oxford University Press.
23
Igben, Robert O. (1999). Financial Accounting Made Simple.
Lagos ROI Publishers.
Ikon, Micheal A. (2004). An Introduction to Business in the
Nigeria Environment. Onitsha: Ngotel Publishers.
Inanga, Eno L. (1999). Principles of Accounting 2nd ed. Ibadan:
Heinemann Educational Books Plc.
Lasher, William R. (1997). Practical Financial Management. St
Paul, MN. West Publishing Company.
McShane,
Steven
L.&
MaryAnn
Von
Glinow
(2000).
Organizational Behaviour. Boston: Irwin McGraw Hill.
Nwachukwu, Vitalis O. & Kelechi G.Egbulonu. (2000). Elements
of Statistical Inference. Owerri: Peace Enterprises Ltd.
Okezie, B. N. (2002). Fundamentals of Financial Accounting.
Owerri: BON Publications.
Omuya J. O. (1983).
Frank Wood’s Business Accounting. West
Africa ed. Volumes 1&2. London: Longman Group Ltd.
24
CHAPTER TWO
REVIEW OF RELATED LITERATURE
2.1 INTRODUCTION
One of the effective ways of communicating financial
information about a business is through financial statements.
Thus, the recording and summarizing of financial data are
necessary part of accounting information system.
However, no matter how well prepared and presented,
financial statements need to be analyzed and interpreted to
unveil the truths hidden in them and enhance decision-making.
Interestingly, such analysis and interpretation can be made by
means of ratios and comparisons.
Therefore, in the this chapter, expert opinion on the role
ratio analysis in business decisions with particular reference to
financial statement analysis are reviewed
2.2 FINANCIAL STATEMENT ANALYSIS
According
to
Hermanson
et
al
(1992:824),
“financial
statement analysis consist of applying analysis tools and
techniques to financial statements and other relevant data to
show important relationships and obtain useful information.”
Therefore, financial statement analysis can be defined as the
25
breaking down, interpretation, and translation of data contained
in financial statements to provide information and show
important relationships among the items of financial statements
and drawing conclusion about the past performance, current
financial position, and future potentials of a business.
2.3 PARTIES
INTERESTED
IN
FINANCIAL
STATEMENT
ANALYSIS
With particular reference to business organizations, parties
interested in financial statement analysis are divided into two
categories, namely: internal users and external users.
The internal users include management and employees of
an organization, while external include shareholders, investors,
creditors, debenture/bond holders, financial analysis, etc.
Management and Employees
Financial
statement
analysis
helps
management
and
employees to know the operating results, financial position and
future potentials of a business.
Shareholders/Owners
The analysis helps shareholders or owners of a business to
ascertain the profitability of the operation of the business, as well
as return on their investments.
26
Investors and Creditors
Financial statement analysis helps investors to know the
profitability and return on investment in a business. In the other
hand, it helps trade creditors and note holders to know the
liquidity or the ability of a business to pay its debts when they
fall due.
Debenture/bond holders
Those who lend money to the business would like to know
the ability of the business to repay on maturity both the interests
and the principal of the loans granted to it.
Financial analysis
Financial statement analysis enables financial analysis to
offer professional advice to their clients on investments.
2.4 OBJECTIVES OF FINANCIAL STATEMENT ANALYSIS
According to Needles et al. (1996:770) financial statement
analysis is used to achieve two basic objectives: (1) Assessment of
past performance and current position, and (2) Assessment
future potential and related risks of a business.
Assessment Of Past Performance And Current Position
Financial statement analysis helps in assessing or judging
the past performance of a business by taking a look at the trend
27
or historical sales, expenses, net income cash flow, and return on
investment. Also an analysis of current position will tell for
example, what assets the business owns and what liabilities
must be paid.
Assessment of Future Potential Related Risk
Information about the past and present (performance) is
useful only to the extent that it bears on decisions about the
future (potentials). Financial statement analysis thus help for
example investors to judge the earning potential of a company. It
also enable creditors to assess the potential debt paying ability of
the company. Therefore financial statement analysis helps in
assessing the riskness of an investment or loan by making it easy
to predict the future profitability and liquidity of a business.
2.5 SOURCES
OF
INFORMATION
FOR
FINANCIAL
STATEMENT ANALYSIS
According to Needles et al. (1996:773), the major sources of
information
about
publicly
held
corporations
are
repots
published by the company, SEC reports, business periodical, and
credit and investment advisory services.
28
Reports Published by the Company
The annual report of a publicly help corporation is an
important source of financial information.
SEC Reports
Annual, quarterly and current financial reports filed by
publicly help corporations with the securities and Exchange
commission (SEC) are sources of information for analysis of
financial statements.
Business Periodicals
Financial magazines and newspapers contain reports about
the performance of companies.
Credit and Investment Advisory Services
There provide data and information about the performance
of companies as well as on industry norm. for example. Dun and
Bradstreet corporation in USA offers an annual analysis using
fourteen rations of 125 industry groups.
2.6 TOOLS AND TECHNIQUES OF INDIANOLA STATEMENT
ANALYSIS
These are various methods and processes used to analyze
financial statements and show relationships and change among
comparative financial data. The most widely used tools for this
29
purpose are horizontal analysis, vertical analysis, trend analysis,
and ratio analysis.
HORIZONTAL ANALYSIS
This is a technique for analyzing financial statements that
involves the computation of changes in both (naira) amounts and
percentages from the previous to the current year. (Needles et
al., 1996:795).
In horizontal analysis, the previous year is
always the base year in calculating the percentage increase or
decrease.
(Dansby et al., 2000:819). The percentage change is computed
as follows:
30
Percentage change
=
Amount of naira change x 100
Previous year amount
Figure 2.1 resents the Comparative Balance Sheet of a
Hypothetical Company known as Toptree Company Ltd. For 2007
and changes.
From 2007 to 2008 for example, Toptree’s total
assets increased by N540 thousand, (from N4,838 thousand to
N5,378 thousand) or by11.2 percent.
This was computed as
follows:
Percentage increase = N540 thousand x 100
N4,838 thousand
= 11.2%
According to Hermanson et at. ( 1992 : 825), “ this type of
analysis helps detect changes in a company’s performance and
highlights trend.” Nevertheless, case must be taken in the
analysis of percentage changes, else they may result to a
distorted view or under estimation of the naira amount changes.
31
FIGURE 2.1
COMPARATIVE BALANCE SHEET WITH
HORIZONTAL ANALYSIS
TOPTREE COMPANY LTD.
COMPARATIVE BALANCE SHEET
AS AT 31 DECEMEBER 2007 AND 31 DECEMEBR 2007 and 31
DECEMBER 2008
2008
ASSETS
2007
N’000
Fixed Assets(Net) 21,910
Increase
N’000
(Decrease)
N’1000
21,760
%
150
0.1
Current Assets:
Inventory
10,820
Accounts Receivable 13,850
Cash
9,650
1,170
11,870
1,980
7,200
5,100
Total Current Assets 31,870
26,620
Total Assets
12.1
16.7
2,100 41.2
5,250
N53,780 N48,380 N5,400
19.7
N11.2
======== ======= ======
======
LIABILITIES & STOCK
HOLDERS’ EQUITY
Current Liabilities:
Accounts Payable
6,800
Dividends
1,200
Taxation
640
Total Current liabilities 8,640
6.020
780
13.0
1,050 150
14.3
610
30
7,680 960
4.9
12.5
Long-term Liabilities:
8% Debentures
4,020
Total Liabilities
12,660
6,100
3,780
(2,080)
(34.1)
(1,120)
(8.1)
32
Stockholders’ Equity:
Common Stock
(N1par,Quoted at N1.20) 20,460
16,900
3,560
21.1
Retained Earnings
17,700
2,969
16.7
20,660
Total Liability &
Stockholders’ Equity N53,780
=====
N48,380
======
N5,400
=====
11.2
===
VERTICAL ANALYSIS
Dansby et al, (2000:846) defines vertical analysis as “the
expression of each item in a company’s financial statement as a
percentage of a base or total figure, in order to see the relative
importance of each item”. For Balance Sheet, the base is total
assets while for income Statement, the base is net sales.
According to Needles et al. (1996:784), the accountant sets a
total figure in the statement equal to 100 percent and computes
each component’s that results is called a common-size statement
as “financial statements that show only percentage and not
absolute { naira) amounts”.
Vertical analysis is useful for comparing the importance of
specific components in the operation of a business. It can also
be used in comparative common-size statements to compare the
performance of a firm with its own history (to identify important
33
changes in the components from one year to the next) or to
compare the business that are substantially different in size.
(Needles et al. 1999;784, Lasher, 2000:67).
For instance, in the hypothetical Comparative Income
Statement with vertical analysis of toptree Company Ltd., shown
in figure 2.2, the cost of sales reduced from 51.9% in 2007 to
5.15% in 2008 whereas the naira amounts increased from
N33,600 thousand in N2007 to N37,500 thousand in 2008.
34
FIGURE 2.2
COMPARATIVE INCOME STATEMENT
WITH VERTICAL ANALYSIS
TOPTREE COMPANY LTD
COMPARATIVE INCOME STATEMENT FOR THE YEARS
ENDED 31 DECEMBER 2007 AND 31 DECEMBER 2008
2008
N’000
Sales (Net)
2007
%
N’000
64,700
%
72,800
100.0
100.0
Opening Inventory
9,650
3.3
10,020
15.5
Add Purchases
38,670
53.1
33,230
51.3
48,320
66.4
43,250
66.8
Less Closing Inventory
10,820
14.9
9,650
14.9
Cost of Sales
37,500
51.5
33,600
51.9
Gross Profit
35,300
48.5
31,100
48.1
Less Operating Expenses
19,513
26.8
17,564
27.1
Income from Operations
15,787
21.7
13,536
20.9
680
0.9
730
1.1
15,107
20.8
12,806
19.8
Less Income Taxes
6,043
8.3
5,122
7.9
Net Income
9,064
12.5
7,684
11.9
Dividend
2,650
3.6
2,500
3.7
Retained Earnings
6,414
=====
8.8
===
5,184
====
8.0
==
Less Cost of Sales:
Less Interest Expense
Income before Taxation
35
TREND ANALYSIS
This is an extension of horizontal analysis in which
percentage changes are calculated and compared for several
successive years, instead of for two years, to show trends or
directions of a company at long run.
According to Needles et al. (1996:782), trend analysis uses
an index number to show changes in related items over a period
of time, (usually 5 years). Each item in the base year (selected) is
assigned the value of 100% and each item in the other years is
expressed as a percentage of the {naira} amount in the base year.
Thus, trend percentage or index can be calculated as follows:
Trend Percentage = Amt for item in any year x 100
Amt for item in base year
For instance, the trend percentage for net sales for 2008 in
the trend analysis shown in figure 2.3 (taking 2004 as the base
year), was calculated as follows:
Trend percentage for net sales (in 2008) = N 72,800 x 100
N 50,800
= 143.3%
36
Hermanson et al. (1992:829) observed: “trend percentages
are used for comparison of financial information over time to a
base year or period’.
FIGURE 2.3
TREND ANALYSIS
TOPTREE COMPANY LTD
NET SALES TREND ANALYSIS
FOR THE FIVE YEARS ENDED 31 DECEMBER 2005
2008
Net Sales (N’000)
Trend Analysis(%)
2007
2006
2005
2004
72,800 64,700 58,900 52,400 50,800
143.3 127.4
115.9
103.1 100.0
RATIO ANALYSIS
Dansby et al. (2000:845) defined ratio as “fractional
relationship of one number to another”.
On the other hand,
Needles et al. (1996:795) defined ratio analysis as “a technique
of financial analysis in which meaningful relationship are shown
between the components of financial statements”. Ratio analysis
is often expressed proportionately to show the relationship
between figures in the Financial statements. It is the core of this
study.
37
Ratios are guides or shortcuts that are useful in evaluating
a company‘s financial position and operations and making
comparisons with results in previous years or with other
companies. The primary purpose of ratio is to point out areas
needing further investigation.
They should be used in
connection with a general understanding of the company and its
environment. (Needles et at., 1996:786).
Thus, Lasher (1997:69) noted are most meaningful when
used in comparison.
For that reason, it is difficult to make a
generalization about with a good or acceptable value is for any
particular figure.
One measure alone does not tell the whole
story about a company and one measure should never be the
sole basis for a financial decision”. Hermanson et al. (1992:840)
added: “standing alone, a single financial ratio may not be
informative. Greater insight can be obtained by computing and
analyzing several related ratios for a company”.
2.8 USES AND OBJECTIVES OF RATIO ANALYSIS
Basically, ratio analysis is used in determining:
(1)
The short-term and long-term liquidity of a firm or the
ability of the firm to meet its short-term (current) and long-term
financial obligations.
38
(2)
The riskness or long-term solvency of a business. That is,
the level of gearing or leverage or the extent the firm is financed
by debt.
(3)
The Performance, profitability or overall earning power of a
business.
(4)
The assets utilization or efficiency in the use of assets of a
business to generate sales revenue.
(5)
The potential return and risk associated with owing shares
or investing in the stock a company.
2.9 TYPES OF RATIO ANALYSIS
Ratio analysis is divided into two types, namely; unviariate
ratio analysis and multi – variate ratio analysis. Meanwhile, for
the purpose of this study, the hypothetical Comparative Balance
Sheet and Income Statement of Toptree Company Ltd., shown in
figure 2.1 and 2.2 respectively will be used to illustrate these.
Also, where a ratio calls for the use of an average amount will be
used where the beginning –of – year amount is not available.
(Hermanson et at., 1992:832).
2.9.1
UNIVARIATE RATIO ANALYSIS
This is the traditional and most popular approach to ratio
analysis used by accounting textbooks. It examines one ratio at
39
a time and shows how it is possible to draw tentative conclusions
by comparing the result of the ratio with some yardsticks of
comparison. By studying a number of ratios in this way, it is
possible to piece together a picture of the company’s performance
and position. Lewis et al., 1996:375).
Owing to its role in achieving the objectives of ratio analysis
discussed earlier, univariate ratio analysis will be the major focus
of this study.
Five of its categories to be discussed include
liquidity Ratios, Profitability Ratios, Assets Management Ratios,
Debt Management Ratios, and Investment Ratio.
LIQUIDITY (SHORT-TERM SOLVENCY) RATIOS
According to Dansby et at. (2000:826) “Liquidity is the
ability of a business to meet its financial obligations as they fall
due”.
One the other hand, Needles et al. (1996 :787) defines
liquidity, as “a company’s ability to pay bills when they are due
and to meet unexpected needs of cash”.
Liquidity ratios can be divided into two – short-term
liquidity (solvency) ratios. However, for the purpose of this study,
liquidity Ratios refer to short-term liquidity ratios while Debt
Management Ratios refer to long-term liquidity ratios.
40
Liquidity
ratios
(short-terms
solvency
ratios)
are
of
particular concern to short-term lenders and suppliers who
provide products and services to the firm on credit. They want to
be sure the company has the ability to pay its debts. (Lasher,
1997:69). Liquidity Ratios include Current Ratio and Quick or
Acid Test Ratio.
Current Ration
This indicates the ability of a business to meet or pay its
short-term financial obligations or current liabilities out of the
current assets.
Thus, it is also known as the ratio of current
assets to current liabilities.
It is the primary measure of a
company’s liquidity.
A low current ratio may be an indication of a firm’s inability
to pay its financial obligations in the near future, while a high
current ratio may indicate excessive amount of current assets or
inefficient asset utilization by management.
The yardstick against which current ratio are measured is
the standard of 2 to 1 (2:1).
This means that for every N1
current liability there must be a minimum of N2 current assets
to cover it. This standard is often used by lending institutions
41
and credit bureau and is generally considered as good. (Dansby
et al., 2000:827).
However, prospective creditors or lenders must take care of
sticking to this standard as a company may manipulate its
current ratio (by inflating inventory for instance,) in order to
paint a picture of better financial position. Current ratio can be
calculated as follows:
Current Ratio
=
Current Assets
Current Liability
For Toptree Company Ltd., Current ratio =
2008
31,870
2007
=
3.7:1
8,640
26,620
=
3.5:1
7,680
From the above computations, it can be deduced that
Toptree’s Current Ratio increased slightly in 2008 over 2007 and
both are good.
Quick (Acid Test) Ratio
This measures the ability of a firm to pay all of its current
liabilities if they come due immediately.
(Dansby et al., 200:
828). It is a better measure of liquidity because unlike current
ratio, it omits stock or inventory (which may not be easily turned
42
into cash) from the current assets to get quick assets.
It is
therefore, the ratio of quick assets to current liability and
indicates a firm’s ability to pay its debt quickly. It is also called
acid test, which implies a particularly tough, discerning test.
(Lasher, 1997:70). The standard for quick ratio is 1:1. Quick or
acid Test Ratio can be calculated as follows:
Quick or Acid Test Ratio =
Quick Assets
Current Liabilities.
For Toptree company Ltd, Current ratio
2008
=
2007
31,870
=
3.7:1
8, 640
26,620
=
3.5:1
7,680
For the above computations, it can be deduced that
Toptree’s Current Ratio increased slightly in 2008 over 2007 and
both are good.
QUICK (ACID TEST) RATIO
This measures the ability of a firm to pay all of its current
liabilities if they come due immediately. (Dansby et al.,
2000:828). It is a better measure of liquidity because unlike
current ratio, it omits stock or inventory (which may not be easily
43
turned into cash) from the current assets to get quick assets. It is
therefore, the ratio of quick assets to current liabilities and
indicates a firm’s ability to pay its debts quickly. It is also called
acid test, which implies a particularly tough, discerning test.
(Lasher, 1997:70). The standard for quick ratio is 1:1 quick or
Acid Test Ratio can be calculated as follows:
Quick or Acid Test Ratio =
Quick Assets
Current Liabilities
i.e
Current Assets -
Inventory
Current Liabilities
For Toptree, Quick Ratio =
2008
2007
31,870 – 10,820
26,620 – 9,650
8,640
= 2.4:1
17,680
= 2.2:1
Form the above computations, it is obvious that Toptree can
pay off its current liabilities without selling any inventory.
PROFITABILITY (ACTIVITY) RATIOS
Profitability refers to the ability of a firm to earn a
satisfactory income or return on investment in the business.
Therefore, profitability ratios measure the profit or money making
44
or earning success of a firm. They are of primary impotent to
stockholders, investors and creditors because earnings produce
cash flows with which to pay dividends and debts.
Profitability ratios are also called activity ratios because
they indicate the ability of firm to earn profits in relation to the
sales made, assets employed, or equity (capital) invested or
employed. They are generally stated as percentages. (Lasher,
1997:76).
Profitability ratios include Return on SALES, return
on Assets, and Return on Equity.
RETURN ON SALES (ROS)
Return On Sales (ROS) is simply percentage of the net
income or profit after tax to net sales. It is also called the profit
merging (or net profit margin). It is a fundamental indication of
the overall Profitability of the business. It gives insight into
management’s ability to control the income statement items of
revenue, cost, and expense (Lasher 1997:76).
ROS can be divided into Gross profit Margin, Operating
Income Margin, and Net profit margin. However, in general terms
and for the purpose of this study, ROS refers to Net profit
Margin.
45
GROSS PROFIT MARGIN
This is otherwise known as the percentage of Gross profit to
Net sales.
It is a measure of efficiency of the sales of a firm in relation
to the cost of goods sold. It indicates a firm’s ability to control
cost of vice versa.
Gross profit margin can be calculated as follows:
2008
2007
15,787 X 100 = 21.1%
13,536 X 100
72,800
64,700
= 20.9%
NET PROFIT MARGIN
This id otherwise called the percentage of Net profit to Net
sales. It is a measure of the proportion of net sales that remains
after the deduction of all costs and expenses. It indicates the
ability of a firm to control operating and non-operating expenses.
Net profit margin can be calculated as follows:
Net Profit Margin
=
Net Income
Net Sales
X
100
46
For Toptree Company, Net profit Margin
2008
=
2007
9,064
X 100 = 12.5%
72,800
7,684 X 100
= 11.9%
64,700
The above figures indicate that the Net profit Margin is far
below the Gross profit Margin in both years. Nevertheless, the
results were generally favorable.
RETURN ON ASSETS (ROA)
Return On Assets (ROA) measures the overall ability of the
firm to utilize the assets in which it has invested to earn a profit.
(Lasher, 1997:76). It indicates the profitability of a firm’s assets,
the amount of net income it earns in relation to the assets
available for use during the year. (Dansby et al., 2000:833). The
higher the ROA the more profitable is the assets in producing
income. ROA can be divided into two, namely; return on
operating Assets and Return On Total Assts. However, in general
terms and for the purpose of this study, ROA refers to return on
Total Assets.
47
RETURN ON OPERATING ASSETS
This measures the Profitability of a business in carrying out
its primary functions, by indicating the proportion of the
operating assets that become net operating income. Operating
assets are all assets actively used in producing operating
revenues. Therefore, non operating assets such as land held for
future use, a factory building ranted to another company, and
long-term bond investments are excluded when calculating
return on operating assets. (Hermasnon et al. 1992:837) The
formula is:
Return on Operating Assets
=
Net Operating Income
Average Operating Assets
Or
Net Operating Assets
Average Total Assets (Where there are no non-operating assets)
For Toptree, Return on Operating Assets =
2008
15,787
53, 780
2007
=
29.3%
13,536
48,380
=
28.0%
48
RETURN ON TOTAL ASSETS
Return On Total Assets quantifies the success of the efforts
of a business in using its assets earn profit by stating net income
or profit after tax as a percentage of total assets.
Return On Total Assets
=
Net Income
X 100
Average Total Assets
For Toptree Company, Return On Total Assets or ROA
2008
2007
9,064 X 100 = 16.9%
7,684 X 100
53,780
48,380
=
=
15.9%
From the above computations, it can be deduced that
although the assets were efficiently used to earn profit in both
years, 2005 was better.
RETURN ON EQUITY (ROE)
Return on Equity (ROE) measures the firm’s ability to earn
a return on the owner’s invested capital. It is the most
fundamental
profitability
ratio
because
stockholders
are
primarily interested in the relationship between net income and
their investment in the company. It states net income as a
percentage of equity. (Lasher, 1997:77). It is known as Return On
49
Capitals Employed (ROCE) or Return On Investment (ROI)
because it shows proportion of capital employed, stockholders
equity or owners investment (total assts less total liabilities or
debts) which return to owners or stockholders as net income.
ROE can be calculated as follows
ROE
=
Net Income
X
100
Average Stockholder’s Equity
For Toptree Company, ROE
=
2008
2007
9,064 X 100 = 22.0%
7,684 X 100 = 22.2%
41,120
34,600
The above results are good, but 2004 is better.
ASSETS MANAGEMENT (EFFICIENCY) RATIOS
Assets
management
ratios
address
the
fundamental
efficiency with which a company is run. (Lasher, 1997:71). They
show how efficiently the business is utilizing or managing assets
(current assets and fixed assets) in generating revenue and cash
flow. Thus, they are also called Efficiency Rations. Asset
management Rations include: Inventory Turnover, Average Days’
Inventory On Hand, Accounts Receivable Turnover, Average
50
Collection period for Accounts Receivable, Total Assets Turnover,
and Fixed Assets Turnover.
INVENTORY TURNOVER
Inventory Turnover measures the number of times in which
the average inventory or stock is sold in a give perio. This is of
prime importance to management because for a business to
generate greater sales volume for the year, it ,must but, sell and
replenish its goods or stock as rapidly as possible. (Dansby et al,
2000:830).
Inventory Turnover an attempt to measure whether or not
the firm has excess funds tied in inventory. A higher inventory
turnover is better in that it implies doing business with less fund
tied up in inventory. A low inventory turnover figure can mean
some
old inventory is on the books that being used. Holding
inventory costs money-it involves the cost of storage, pupilage,
obsolescence, etc.
The ratio is calculated as follows:
Inventory Turnover
=
Cost of goods sold
Average Inventory
51
For Toptree, Inventory Turnover
=
2008
2007
37,500
=
3.7times
33,600
(9,650+10,820)/2
= 3.4times
(10,020+9,650)/2
From the above calculations, in can be understood that
although Toptree’s Inventory Turnover increased slightly in 2005
over 2004, the business had very low rate of turnover in both
years.
AVERAGE DAYS’ INVENTORY ON HAND
This is a measure of average number of days taken to sell
inventory. It is an extension of inventory turnover and thus help
a firm to know the speed at which it sells inventory or stock.
The ratio computed as follows.
Average days’ inventory on hand
=
365 days
Inventory Turnover
For Toptree, Average Days’ Inventory on hand =
2008
365 days
3.7
2007
= 98.6 days
365 days =
3.4
107.4 days
52
From the above computations, it could be understood that
although there was improvement in 2008, Toptree holds stock
for very long time in both years before they are sold.
Accounts receivable turnover
Accounts receivable turnover is a measure that indicates
how quickly a company is collecting its accounts receivable. It is
the number of times per year that the average amount of
accounts receivable or debtors is a collected (Dansby et al.
2000:829). It measurers the relative size of accounts receivable
balance and effectiveness of credit polices. The higher the
accounts receivable turnover.
Accounts receivable Turnover can be calculated as follows:
Accounts Receivable Turnover =
Net Credit Sales
Average Accounts Receivable
Or
Net Sales
Accounts Receivable
(where net credit sales and average accounts receivable are not
possible or available.).
53
Therefore, for Toptree, Accounts Receivable Turnover
2008
=
2007
72,800
= 5.3 times
13,850
46,700 = 5.5 times
11,870
From the above computations, it can be understood that
Toptree’s already low accounts receivable turnover reduced the
more in 2008
Average collection period for accounts receivable (acp)
This is a measure of length of time taken to collect accounts
receivable or number of days accounts receivable or debtors have
been outstanding. It is determined by dividing the number of
days in the year by the accounts receivable turnover. Thus it is
an extension of accounts receivable turnover. (Dansby et al
2000:830). The ration measures average liquidity of accounts
receivable and gives an indication of their quality. A comparison
of the average collection period with the credit extended
customers by a company or the firms, credit extension policy will
provide further insight into the quality of accounts receivable.
The formular for this ration is
ACP =
365 days
Accounts Receivable Turnover
54
For Toptree, ACP
2008
=
2007
365 days =
68.9 days
5.3
365 days =
66.4 days
5.5
Depending on the credit terms, the above computation show
that Toptree’s ACP is long. That is, the credit sales stay over 2
months before they are collected. This indicated poor collection
effort.
Total assets turnover (tat)
Total assets turnover (TAT) measures how efficiently assets
are used to produce sales. (Needles et al., 1996:789). It is a
measure of the magnitude of net sales generated by the assets of
the firm. The higher the assets turnover rate, the better the firm
is using its assets to generate sales. In other words, the larger
the total assets turnover, the larger will be the income on each
(naira) invested in the assets of the busing. (Hermanson et al.,
1992: 834). TAT can be calculated as follows.
TAT =
Net Sales
Average Total Assets (excluding investments)
Investments are excluded from the formular since they are
not intended\ to produce sales. (Dansby et al., 2000:834). In
55
other words, the ratio is known as Turnover of Operating Assets,
because it to generate sales revenue. (Hermanson et al.,
1992:837).
For Toptree Company, TAT
2008
=
2007
72,800
=
1.4 times
53, 780
64,700
=1.3times
48,380
Toptree’s assets turnover rates of 1.3 times and 1.4 times in
2007 and 2008 respectively are not high. This could mean that
the firm is not generating enough sales for the amount of assets
it has available. However, the fact that this is just one measure
should compel the firm to compare it with the figure shown by
similar business in the same industry.
Fixed assets turnover (fat)
Fixed assets Turnover (FAT) measures the capacity of fixed
assets in producing sales. It shows the relationship between fixed
assets and sales. The ratio is appropriate in industries where
significant equipment is required to be business. (lasher,
1997:73). A Lower FAT or a reducing sales being generated from
each naira invested in fixed assets may indicate over capacity,
poorer-performing equipment, or under utilization of fixed assets.
56
FAT can calculated as follows:
FAT =
Nest Sales
Average fixed Assets
For Toptree, Fat
=
2008
2007
72,800
=
3.3 times
21,910
64,700
= 3.0 Times
21,760
from the above computations it can be deduced that Toptree
improved its equipment utilization in generating sales in 2005.
Debt management (long-tem solvency) ratios
Debt management Ratios measure how the firm uses other
people’s money to its own advantage. The primary concern is to
ensure that the firm does not borrow so much that becomes
overly risky. (Lasher, 1997:73).
Therefore debt management ratios measure the briskness of
a business. They are also known as long-tern solvency, liquidity
or stability ratios because they focus on the long-tern stability
and capital structure of the firm. They are of interest to
management, stockholders and creditors. Management want to
know the long-term stability of the business. Creditors want to
make user funds are available to pay interest and principal.
57
Stockholders are concerned about the impact of excessive debt
and interest on long-term Profitability of the business. (Lasher,
1997:76).
Thus, Debt Management Ratios tell the size of owner’s
investments in the business as well as the strength of the
business to pay its total liabilities (current and-term liabilities) or
all of its financial obligations to outsiders at long run. Therefore,
for the purpose of this purpose of this study, debt refers to total
debt or total liabilities.
Debt management Ratios include Debt Ratio, Equity Ratio,
debt-to Equity Ratio, Leverage Ratio, Fixed Assts to Long-term
liabilities, times interest Earned, cash Coverage and fixed charge
coverage.
Debt Ratio
Debt Ratio measures the relationship between total debt
and equity in supporting assets of a business. It tells how much
of the firm’s assets are supported by other people’s money.
(Lasher,1997:74). It ia also known as the ratio of total liabilities
to total assets, because it shows the proportion or percentage of
total assets supported by debt or total or debt. A high debt ratio
is viewed as risky by investors, especially lenders.
58
Debt ratio calculated as follows:
Debt ratio
=
Total Liabilities
x
100
Total Assets
For Top tree, the debt ratio
2008
=
2007
2,660 x
100 = 23.5%
53,780
13,780 x 100 =28.5%
48,380
From the above results, it can be seen that although the
debt ratio is good in both years, the firm appears less risky in
2008.
Equity (proprietary) Ratio
This is the opposite of debt ratio. It measures the extent to
which assets of the financed by stockholders or owners of the
business. In other words, equity ratio indicates proportion of
total assets of the business that is supported by the owner’s fund
or resources. The higher the ratio, the better and more secure or
solvent is the firm.
Equity Ratio can be calculated as follows:
Equity Ratio
=
Stockholders’ Equity
Total Assets
x
100
59
For Top tree, Equity Ratio
=
2008
2007
41,120 x 100 = 76.5%
34,600 x 100 =
53,780
48,380
71.5%
Debt-To-Equity Ratio
This ratio is a measure of mix of debt (total liabilities) and
equity within the firm’s total capital. It states the amount of
owners’ equity in relation to a company’s total liabilities, it is an
important measure of risk because a interest charges. This
makes the firm’s profitability fragile in reversionary times.
(Lasher, 1997:74). It is also known as debt-equity ratio. The
higher the ratio, the better the position of the company in the
eyes of its creditors, lenders, investors and shareholders.
Debt-Equity Ratio is calculated as follows:
Debt-to-Equity Ratio =
Stockholders’ Equity
Total Liabilities
For Top tree, Debt-to-Equity Ratio
2008
41,120
12,660
=
2007
=
3.2:1
34,600
13,780
=
2.5:1
60
Form the above results, it is obvious that Top tree’s debtequity ratio is good in both years but 2008 is better.
Leverage (Gearing) Ratio
This is similar to ratio but the only difference is that it
measures the size of long-term liabilities or fixed-interest debts in
comparison with the stockholders’ or owners’ equity. The
standard for this ratio is 1:1. a firm with high leverage ratio is
said to be highly geared and such makes the firm to be
financially because high interest charges will reduce the
profitability of the business as well as dividends payable to
shareholders, especially in times of economic downturns or
fluctuations in earnings. In practice, a gearing ratio greater than
0.6:1 is often regarded as high while the one that is less than
0.2:1 is regarded as low. The lower the gearing, the better and
more secure the company is to settle long-term debts.
Leverage (Gearing) ratio can be calculated as follows:
Leverage Ratio =
Long-term Liabilities
Stockholders’ Equity
61
For Top tree, leverage Ratio
=
2008
4,020
2007
=
0.1:1
41,120
6,100
=
0.2:1
34,600
From the above results, it is clear that Top tree is lowly
geared. It has a good and improving gearing ratio.
Fixed Assets To Long-Term Liabilities
This measures the strength of fixed assets of a business to
provide collateral security or cover for the long-term liabilities.
The higher the ratio, the more secure the long-term creditors or
lenders. A ratio of 2:1 or higher provides a margin of safety to
long-term note holders. (Dansby, et al., 200:832). The ratio is
calculated as follows:
Fixed Assets to Long-Term Liabilities= Fixed Assets
Long-Term Liabilities
For Top tree, the ratio is calculated thus:
2008
2007
21,910
4,020
=
5.5:1
21,760
=
3.6:1
6,100
As shown above, it is clear that Top tree has a strong and
improving ratio of fixed assets to long-term liabilities. Thus, it is
62
in a good position to secure additional long-term credit facilities,
and using the firm’s plant assets as collateral.
Times Interest Earned (TIE)
TIMES interest Earned (TIE) measures the number of times
interest expense can be paid out of earnings before interest and
taxes (EBIT) or income from operation. It is also called Interest
Coverage Ratio, and indicates the credit worthiness of a firm.
According to Hermanson et al. (1992:842), “TIE helps creditors,
especially long-term creditors to know whether a borrower can
meet its required interest payments when these payments come
due”. The higher the ratio, the safer it is to lead the firm more
money.
TIE is calculated as follows:
TIE =
Income from Operations or EBIT
Interest expense
For Top tree, TIE
2008
15,787
680
=
2007
=
23.2 times
13,536 = 18.5times
730
63
From the above computations, it is apparent that Top tree
has a very strong and improving interest coverage ratio and is
therefore, more credit worthy.
Cash Coverage
This is an extension of TIE, but considers the number of
times interest expended can be paid out of the cash flow or cash
earnings (income from operations or EBIT plus depreciation or
non cash expense). It indicates the strength of the firm to pay
interest charges out of the actual cash earnings of the firm. In
other
words,
cash
coverage
compares
cash
inflows
from
operations with cash outflows for interest expense. (Hermanson
et al., 1992:842). The ratio can be calculated as follows:
Cash Coverage =
Income from operations + Depreciation
Interest
Fixed Charge Coverage (FCC)
This is an extension of TIE where lease payments are
recognized as fixed financing charges. FCC thus shows the
number of times fixed charges can be paid out of income from
operations or EBIT. It must be noted that fixed charges are
payments that must be made regardless of business conditions.
FCC can be calculated as follows:
FCC =
Income from operations
Interest
+
+
Lease Payments
Lease Payments
64
Assuming that in case of top tree, lease payment of N720
thousand and N740 thousand were made by the firm in 2007
and 2008 respectively, the
FCC =
2008
2007
15,787 + 740 = 11.6 times
13,536 + 720 = 9.0 times
680 + 740
730 + 720
INVESTMENT (MARKET VALUE) RATIOS
These measure the performance or market value of
investment in the shares or stock of a firm. Investment ratios
provide investors information about the potential return and risk
associated with owing shares in a company. (Needles et al.,
1996:793). Thus, they guide investors in their investment
decisions in a company.
In fact, investment rations indicate the profitability of
investing in the shares or stock of a company. They show the
relationship between the earnings of the firm or dividend paid by
the firm and the market price of its shares. Investment ratios
include earnings Per Share, Price/ earnings Ration, Earnings
Yield, Dividend Coverage, and market to book value Ratio.
Earnings per share (EPS) is the amount of net income
available to the owner of each share of common stock or ordinary
share in existence over a particular period. In the words of
Hermanson et al. (1992:840), “EPS is probably the measure
used, most widely to appraise a company’s operations. The
Accounting
Principles
Board
(APB)
noted
the
significance
65
attached to EPS by requiring that such amounts be reported on
the face of income statement”.
EPS is calculated as follows:
EPS = Net income
or profit After Tax and Preferred Dividend
Average number of common stock
Number of Ordinary Share
outstanding
For Top tree, EPS =
2008
2007
9,064
=
N0.44
20,460
7,684
= N0.45
16,900
The above figures show that although Top tree’s net income
increased in 2005, the net income for each N1 common stock
decreased from 45k in 2004 to 44k in 2005.
Price/Earnings Ratio (P/E)
Price/Earnings Ratio (P/E) ratio is a measure of investor
confidence in a company or how the stock rates or values a
business. It indicates the future prospects of stock. (Dandby et
al. 200:836). The ratio compares the market price of the stock to
the EPS calculated from the latest income statement. It tells how
much or number of times investors are willing to pay for a naira
of the firm’s earnings. The higher the P/E ratio the better,
66
because a naira of earnings translates into more shareholder
wealth at higher P/E ratio.
The ratio can be calculated as follows:
P/E = Market Price Per Share of common stock
EPS
For Top tree, P/E =
2008
2007
1.20 =
2.7 times
0.44
1,18 =
2.6 times
0.45
Top tree’s slight improvement (as shown above) suggests
that stockholders have a higher future earnings expectations.
This will attract more investors to the company.
Earnings Yield
Like
P/E
ratio,
Earnings
Yield
indicates
return
on
investment. It is inverse of P/E ratio expressed as a percentage.
It shows EPS in proportion to market price per share. The higher
the earnings yield the better the return on investment on the
stock of a firm. The ratio is calculated as follows:
67
Earnings Yield =
EPS
x
100
Market price per share
Or
1
x
100
P/E
For Top tree, earnings Yield
=
2008
2007
0.44 x
100 = 36.7%
0.45 x
1.20
100 = 38.1%
1.18
Dividend Per Share (DPS)
Like EPS, Dividend Per Share (DPS) measures the amount
of dividends paid per ordinary share outstanding. It shows the
amount of returns earned by investors in terms of dividend in
relation to their investment in each unit of common stock. The
higher
the
DPS
the
better
the
returns on stockholders’
investment as well as the share holds’ wealth. DPS can be
calculated as follows:
DPS =
Dividend
Number of common stock outstanding
68
For Top tree, DPS
=
2008
2007
2,650
=
N0.13
2,500
20,460
=
N0.15
16,900
The above results show that Top tree’s DPS is diminishing.
Dividend payout Ratio (DPR)
Dividend Payout Ratio (DPR)
DIVIDENE
PAYOUT
ratio
(DPR)
reveals
the
dividend
payment and retention policy of the firm. It measures the
percentage of a firm’s distributable earnings that paid out to
ordinary shareholders as dividends. The balance or retained
earnings is reserved as part of shareholders’ fund to meet future
financial needs. It is the percentage of DPS to EPS. The ratio is
calculated as follows:
DPR =
DPS X
100
EPS
For Top tree, DPR =
2008
0.13 x 100
0.44 %
2007
= 29.5%
0.15 x
0.45%
100
=
33.3%
69
Dividend Yield
Dividend yield is an investment profitability measure that
tells the investor the rate earned on an investment in common
stock. It is a measure of current return to an investor in common
stock. Dividend Yield is of particular interest to the investor who
is comparing choices of investment and wants to know the rate
that can be earned. (Dansby et al., 2000:837). It can be
calculated as follows:
Dividend yield DPS
X
100
Market price per share
For Top tree, Dividend Yield
2008
=
2007
0.13 x
100
=
10.8 %
1.20
0.15
x 100
=
12.7%
1.18
Dividend Coverage
Dividend coverage measures the number of times the
earnings of a firm can pay or cover dividend. It indicates the
extent to which earnings will drop before a company may be
unable to maintain the current dividend payout levels. The
higher the ratio the better.
The Formular for Dividend Coverage is:
70
Dividend Coverage=
Net Income or Profit after tax &preferred Dividend
Dividend
Dividend on Ordinary Shares
For top tree, Dividend coverage =
2008
2007
9,064
=
3.4 times
2,650
7,684
=
3.1 times
2,500
Market To Book Value Ratio
This compares the market price per share of a company to
the book value per share. It is a broad indicator of what the
market thinks of a particular stock or how the investors value
the stock. A healthy company is usually expected to have a
market value of its shares in excess of the book value. A market
to book value below 1.0 indicates grave concern about the
company’s future. Such a firm is said to be selling “below book”.
(Lasher, 1997:78).
It must be noted that Book Value Per Share is total value of
equity divided by number of common stock outstanding.
Market to Book Value Ratio is calculated as follows:
71
Market to Book Value Ratio
=
Market Price Per Share
Book Value Per Share
Or
market price per share
Equity
(Number of shares outstanding)
For Top tree, Market to Book Value Ratio =
2008
2007
1.20 =
0.6
1.18
(41.120)
(34,600)
(20,460)
(16,900)
= 0.3
The above computations indicate that investors do not value
the stocks of company. This is a cause for alarm.
2.9.2
MULTIVARIATE RATIO ANALYSIS
Multivariate Ratio Analysis involves the combination of
many ratios to draw conclusion on the overall effect of the
various ways of running a business on the performance of the
business or a particular ratio.
Although not popularly used in textbooks, these ratios show
important relationships between some of the univariate ratios
discussed earlier. Two of such ratios developed by Du Pont
72
Corporation are called Du pont Equations (DPEs). (Lasher,
1997:80).
Du pont Equations (DPEs)
These give insight into overall effect of assets management
and debts management on the profitability of the business. They
focus on the relationship between Return On Assets (ROA),
return on Sales (ROS), Total Assets Turnover (TAT), Equity Ratio
and return on Equity (ROE). They indicate how the performance
of a firm in these ratios reflect on the earning ability and the
managerial efficiency of a firm.
In fact, DPEs draw insight into areas or aspects of the
business-ROS (profitability) to be TAT (efficiency) to be regarded
as responsible for any return (ROA or ROE) made from the
business. For instance DPEs may help us see how a firm whose
ROS is above industry average may be forced to produce a ROA
which is below industry average, due to low TAT (which is below
industry average).
The first Du pont Equation is developed by writing the
definition of ROA and multiplying by sakes/sales ( = 1, so that
the multiplication does not change the value of expression).
The equation is stated a follows:
73
ROA =
Net Income
x
Total Assets
Sales
Sales
Reversing the order of the denominator:
ROA =
Net Income
x
Sales
That is, ROA =
Sales
Total Assets
ROS X
TAT
This shows that ROA is a product of ROS and TAT. Well, it
must be recalled that ROA is a fundamental measure of
performance indicating how well a company uses its assets to
generate profits. ROS measures how well a firm keeps some of its
sales naira in profit. And TAT measures the company’s ability to
generate sales with the assets it has.
Therefore, the above Du pont Equation tells us that to run a
business well as measured by ROA, we have to manage costs and
expenses well and generate a lot of sates per naira of assets.
(Lasher, 1997:80).
For Top tree, the ROA (using the above Du pont Equation)
=
2008
2007
9,064x72,80 x 100 = 16.9%
7,684 x 64,700 x 100 = 15.9%
72,800 53,780
64,700
48,380
74
The second but extended Du pont Equation is developed by
writing the definition of ROE and multiplying sales/sales and by
total assets/total assets. The equation is stated as follows:
ROE =
Net Income
Equity
x
Sales
Sales
x
Total Assets
Total Assets
Re-arranging the denominators:
ROE =
Net income
Sales
=
Sales
Sales
That is, ROE =ROA x
Then, ROE
x
x
Total Assets
Equity
Equity Multiplier.
ROA x Equity Multiplier.
It must be noted that the equity multiplier has to do with
the idea of leverage, using borrowed money instead of your own
to work for you. In fact, the equity multiplier is related to the
proportion to which the firm is leveraged, geared or financed by
other people’s money as opposed to owner’s money. The more the
leverage, the larger the equity multiplier.
The extended Du pont Equation says something very
important about running a business. The operation of the
business itself is reflected in ROA. This means managing
customers, people, Costa, expenses and equipment. But that
result, good or bad, can be multiplied by borrowing. In other
75
words, the way you finance a business can greatly exaggerate the
results of “nuts and bolts” operations. (Lasher, 1997:81).
For Top tree, ROE (using the Extended Du pont Equation)
=
2008
2007
9,064x 72,800 x 53,780 x 100 7,684x64,700x48,380x 100
72,800 53,780 41,120
=
64,700 48,380 34,600
22.0%
= 22.2%
Application of DPEs
Comparing Du pont Equatiions between a company and an
industry average can give some insights into how a firm is doing
in relation to its competitors. For example, we have the following
data for Top tree Company and its industry.
ROA
=
ROS
X TAT
Top tree Company
16.9%
12.5%
1.35 X
Industry Average
19.3%
5.5%
3.5 X
If Top tree is trying to figure out why its ROA is below
average, this display focuses attention in the right direction.
It says that management of income statement items like
cost and expense is little better than average, but use of assets
turn over, is very poor in comparison to the competition.
76
The turnover problem is probably in one or both of two
areas. Perhaps inventory or inefficient machinery. Or maybe its
promotional activities are not on target, so sales are lower than
they should be. The job is now to find out what’s going on and fix
the problem. (Lasher, 1997:81).
2.10 LIMITAIONS OF RATIO ANALYSIS
According to Hermanson et al. (1992:846), “financial
analysis relies heavily on informed judgment. Percentages and
ratios are guides to aid comparison and useful in uncovering
potential strengths and weaknesses. However, the financial
analysis should seek the basic causes behind changes and
established trends.” This means that, although financial ratios
help us identify areas of the business that, although financial
ratios help us identify areas of the business that requires further
investigation, make informed business decisions and asks the
right questions, they do not provide answers or solutions due to
the following limitations:
1.
Differences in Accounting Policies and Procedures:
Accounting policies and methods of companies differ. This makes
cross-sectional analysis difficult. For instance, firms adopt
different methods of depreciation, stock-valuation, treatment of
77
goodwill, preference shares, and research and development coat,
and such may result to differences in the net income of
essentially identical firms.
2.
Inflation: Financial statements do not reveal the impact of
inflation on the reporting entity. (Hermanson et al), (1992:848).
Real estate purchased years ago for example, will be carried on
the Balance sheet at its original cost. Yet it may be worth many
times the amount in today’s market. During periods of rapid
inflation, inventory, cost of sales and depreciation can badly
distort true results. (Lasher, 1997:82,83).
3.
Window Dressing: In a deliberate attempt to make Balance
sheets look better than they otherwise would, firms try to make
some year-end improvements that don’t last, in their finances.
For instance, a company with a low current ratio may try to
improve it by borrowing a long-term loam a few days before the
end of the year, holding the proceeds in cash over year-end, and
repaying the loan a few days later.
4.
Historical Information: financial ratios are computed from
historical accounts, and historical information is of little use in
assessing future prospects of a company. This is because trends
do reverse and past may not be a useful measure of adequacy.
78
Thus, past performance may not be enough to meet present
needs and make reliable projections.
5.
Uniqueness Of Companies: Every Company is unique in
size, operation, management, and location. Thus, two companies
that
operate
in the
same
industry
may
not be
strictly
comparable. For instance, comparing a firm which finances its
fixed plant through rental, (thus not showing it as an asset), with
a firm which purchases its own assets will be difficult
irrespective of their operation in the same industry or sector.
(Omuya, 1983:456).
6.
Limited Information: Financial statements do not present
information that covers all aspects of the business. Therefore,
financial
ratios
provide
only
quantifiable
or
quantitative
information and omits non-quantifiable or qualitative information
such as managerial skills, staffing requirement, and changes in
the operating environment, which are all necessary variables
determining the success of a business.
7.
No Universal Standard: Financial ratios do not have
universally
accepted
standards,
norms
or
yardsticks
for
comparison. Standards are used in accordance with industry,
firm, circumstance and objective pursued. For instance, the rule-
79
of-thumb measure of 2:1 used in current ratio may not be
acceptable in certain situations or firms in consideration of some
managerial policies.
8.
Interpretation: Interpretation of ratios is not always clear.
Interpretation of changes in a ratio needs careful examination of
changes in the figures used in the computation (both the
numerator and denominator). Without a very full and detailed
investigation, some wrong conclusions can be drawn. Also, only
experts can understand and interpret ratios properly. (Omuya,
1983:456).
9.
Underestimation: Ratios often present different picture of
companies from the naira figures and results. The actual naira
results or effects of the business may be disregarded or
underestimated as ratios are stated in small figures. For
instance, millions of naira may be represented by decimal
numbers or figures less than 100. This may make people to
underestimate the meaning of financial ratios or effect of the
operations of a business on its success.
80
REFERENCE
Dansby, Robert L. Burton S. Kaliski, & Michael D. Lawrence.
(2000). Paradigm College Accounting. 4th ed. st. Paul, MN:
Paradigm publishing Inc.
Hermanson, Roger H. James Don Edwards, & Michael W.
Maher. (1992). Accounting Principles. 5th ed. Boston MA:
Richard D. Irwin, Inc.
Lasher, William R. (1997). Practical Financial Management. St.
Paul, MN: West publishing Company.
Lewis, R. et al. (1996). Advanced Financial Accounting. 5th ed.
London: Pitman Publishing Company.
Needles, Belverd E. et al. (1996). Principles of Accounting. 6th ed.
Boston: Houghton Miffin Company.
Omuya, J.O. (1983). Frank Wood’s Business Accounting. West
African ed. Volumes 1 & 2. London: Longman Group Ltd.
81
CHAPTER THREE
RESEARCH METHODOLOGY
3.1 INTRODUCTION
This chapter describes the methods and procedures used in
geothermic data that was analyzed in chapter four, necessary to
accomplish the purpose of this study. The research methodology
is vital part of the research report because according to Osuala
(1987:32), it is the background against which the reader
evaluates the findings and the contusions.
3.2 RESEARCH DESIGN
This study is a surrey designed to find out the role of ratio
analysis in business decisions; it is descriptive and analytical in
nature.
3.3 DATA COLLECTION TECHNIQUE
The two main sources of data collection used in the study
are the primary and the secondary sources.
*
PRIMARY SOURCES
Primary sources of data collection are first hand information
i.e. information that was gathered by the researcher himself
directly from the respondents. In this regains, questionnaire and
oral interviews were used to collect the requisite data from the
82
respondents the management staff and non-management staff of
the organization under study.
*
SECONDARY SOURCES
Secondary sources of data collection are information’s that
were obtained from published maternal such text books,
journals, magazines, newspapers, articles, and so on, which were
considered necessary for the purpose of this research. They were
the major sources from which the knowledge and opinions of
experts in the subject from which the.
3.4 POPULATION
According to Nsini et al. (2000:20), population is any
theoretically specified aggregation of items, elements or things
with common characteristics or interest.
The population of the study is 27 members of the
management and staff of O. Jaco Bros, Ent. (Nig) Ltd, Aba, Abia
state. it cores all the departments of sales and marketing, the
purchase and supply department, the administration and
personnel department and the finance and accounts department.
All the is staff of these departments are further grouped into two
groups namely; management staff and Non management staff.
83
The management staff comprises of administration and
personnel
department,
and
the
finance
and
accounts
departments. While the Non-management staff comprises of the
sales and marketing department, and purchasing and supply
department.
3.5 SAMPLE SIZE AND SAMPLING TECHNIQUE
Sample size is the part of the population that was selected
for the study.
The Yaro Yamene technique was adopted for this research
work to determine the sample size.
Thus n
N
=
1+ N (e) 2
Where; n = sample size
N = population (27 persons)
1 = Unity
(e) 2 =
n=
(a constant)
level of significance ((e) = 0.05)
27
1 + 27 (0.05) 2
n=
27
1 + 27 (0.025)
84
n=
27
1+ 0.065
n=
27
1.065
=
25.3521
=
25 Approximately.
;.
Sample size = 25 persons
The sample size above shows that out of the total
population of 27 persons only 25 persons will be selected and the
questionnaire to be distributed will be only 25 copes.
3.6 INSTRUMENT FOR DATA COLLECTION
Owing to the departments collared by this study, a
questionnaire was designed for data collection and analysis. Data
was also collected through relevant journals, oral interviews,
textbooks, and literature from authors.
3.7
QUESTIONNAIRES ADMINISTRATION
The questionnaires used for the study was made up of 10
questions. It was mainly designed in such a way that alternative
answers were produced for the respondents.
Random method was used for the distribution of the
questionnaires to the respondents.
85
REFERENCE
Akpakpan, B.A (2005). Guideline on Project Writing: Introducing
Students to Research Through Practical Approach. Revised
ed. Uyo: Abaam Publishing Co.
Hoel, P.G (1984). Introduction to Mathematical Statistics. 4th ed.
New York: John Willey and sons Inc.
Nsini, K.M. & N.S. Udoh (2000). An Introductory Statistics. Uyo:
Omniscient printing Press.
Nwachukwu, Vitalis O. & Kelechi G. Egbulonu (2000) Elements
of Statistical Inference. Owerri: Peace Enterprises Ltd.
Osuala, E.C (1987) African – Feb Publishers Ltd.
86
CHAPTER FOUR
DATA PRESENTATION, ANALYSIS AND INTERPRETATION
4.1 INTRODUCTION
In every research study, the method of presentation and
analysis of data is paramount to the extent that it determines the
validity of such data been tested.
Therefore, in this chapter, the researcher has been able to
present and analyze data using questionnaire as specified in
chapter three.
4.2
DATA PRESENTATION AND ANALYSIS
The data presented and analyzed was done in tables. This
was carried out with the actual number of respondent that
returned their questionnaire. Mean while, as shown in the table
4.1 below, 20 out of 25 copies of questionnaire administered were
returned by the respondents, while the remaining 5 were not
returned.
87
TABLE
4.1
QUESTIONNAIRE
DISTRIBUTIONS
AND
COLLECTION
Staff position
Administered
Returned
Mgt, Staff
5
20%
5
Non-Mgt. staff
20
80% 15
Total
25
100%
20
Not returned
20% 0
0%
60%
5
20%
80%
5
20%
As shown in the table above, 20 (80%) of the total number
of questionnaire distributed were returned, while 5 (20%) were
not returned.
The questionnaire used in the data collection had 11 questions.
The first 2 questions (question 1 and 2) relates to the sexes and
staff positions of the respondents respectively. The remaining
Que 5 - Que 11 questions were used to achieve the objectives of
the study.
However, as stated earlier, only questions that are must
relevant to the research questions were presented and analyzed.
In these regards, the response given to question 5,6,7,8,9,10 and
11 were presented and analyzed, as well as used he draws the
conclusions.
88
4.2.1 QUESTION NO 5
What is the highest education qualification level obtained?
TABLE 4.2 HIGHEST EDUCATION QUALIFICATION LEVEL
OBTAINED
Level
Mgt. Staff
Non mgt. staff
Total
Msc
1
5%
-
Bsc
2
10%
-
0%
2
10%
Hnd
2
10%
6
30%
8
40%
Ond
0
0%
7
35%
7
53%
O level
0
0%
2
10%
2
10%
Total
5
25%
15
75% 20
0% 1
5%
00%
SOURCE: QUESTIONNAIRE
From the table 4.2 above showing the highest qualification
education obtained by all the staff, shows that 1 (5%) out of 5
(25%) is an Msc holders, 2 (10%) out of 5 (25%) of the
management staff are Bsc holders, 2(10%) out of 5 (25%) of the
management staff are HND holders. Coming to the Non
management staff 6 (30%) out of 15 (75%) are HND holders, 7
(35%) out of 15 (75%) are OND holders, while 2 (10%) of the
remaining are O level holders.
89
4.2.2 QUESTION NO 6
Do
you
agree
that
Ratio
Analysis
facilitates
proper
understanding of information contained in financial statements?
TABLE 4.2 RETIO ANALYSES AS A FACILITOR OF PROPER
UNDESTANDING OF FINANCIAL STATEMENTS
Responses
Mgt. Staff
Non-mgt. staff Total
Yes
5
20% 15
No
0
0% 0
Total
5
20% 15
75%
20
0% 0
75%
20
100%
0%
100%
SOURCE: QUESTRIONNAIRE
As shown in the table above all the 20 (100%) of
respondents
agreed
that
Ratio
Analysis
facilitates
proper
understanding of information contained in financial statements.
4.2.3
QUESTION NO 7
Do you think that Ration Analysis is useful to management,
investors, shareholders and creditors in their business decisions?
90
TABLE 4.4 USEFULNESS OF RATIO ANALYSIS IN BUSINESS
DECISIONS.
Responses
Mgt. staff
Non mgt. staff
Total
Yes
5
25%
13
65%
18
No
0
0%
2
10% 2
Total
5
25%
15
75%
20
90%
10%
100%
SOURCE: QUESTIONNAIRE
The table above shows that i8 out of 20 or (90%) out (100%)
of the respondents agreed that Ratio Analysis is useful to
management, investors, shareholders, and crediting in their
business decisions.
4.2.4 QUESTION NO 8
Do you believe that efficient use of financial ratios helps is
evaluating and predicting the performance and financial position
of a business, as well as identifying areas that require
improvement?
91
TABLE 4.5 USE OF FINANCIAL RATIOS IN EVALUATION AND
PREDICTION OF BUSINESS PERFORMANCE
Responses
Mgt. staff
Non mgt. staff
Total
Yes
5
25%
12
60%
17
No
0
0%
3
15%
3
15%
Total
5
25%
15
75%
20
100%
85%
SOURCE: QUESTIONNAIRE
Table 4.4 shows that 17(85%) out of 20 (100%) of the
respondents agreed that efficient use of financial ratios helps in
evaluating and predicting the performance and financial position
of a business.
4.2.5 QUESTION NO 9
Do you agree with the saying that ratio Analysis helps us to
ask the right questions but do not provide answers unless the
right comparative standards and techniques are used.
TABLE 4.5 RATION ANALYSIS PROVIDE THE RIGHT ANSWER
WHEN RIGHT COMPARATIVE STANDARDS AND TECHNIQUES
Response
Mgt. staff
Non-mgt.staff
Total
Yes
5
25%
10
50%
15
75%
No
0
0%
5
25%
5
25%
Total
5
25%
15
75%
20
100%
92
SOURCE: QUESTIONNAIRE
From the table 4.5 above it shows that 5 (25%) the mgt,
staff agreed with the fact that Ratio Analysis answers the right
Question when the right comparative and technique are used, 10
(50%) of the non mgt, staff also agree. While 5 (25%) of non-mgt,
staff did not agreed with that saying.
4.2.6 QUESTION NO 10
Are there obstacles to the proper use of financial ratios in
business decisions?
TABLE 4.7 OBSTACLES TO THE USE OF FINANCIAL RATIOS
Responses
Mgt, staff
Non-mgt, staff Total
Yes
5
25%
14
No
0
0%
Total
5
1
25% 15
70%
19
95%
5%
1
5%
75%
20
100%
SOURCE: QUESTIONNAIRE
From the table above, it can be deduced that 19 (95%) out
of the 20 respondents agreed that there are obstacles to the
proper use of financial ration in business decisions.
93
QUESTION NO 10b (ANSWER)
Obstacles to the use of financial ratios:
*
A financial ratio deals only with numerical items and does
not look at
*
In periods of inflation, the ratios comparing sales and net
income to non-numerical factors like management’s ethical
relies. assure and equity may be biased upwards.
*
Ratios show relationship as they exist in the past at a
particular
balance sheet date. Therefore analyst interested
in the future should be mislead into believing that the past
data necessary reflects the current or future situation.

Obstacles such as economic, socio culture, political,
climatic and competitive conditions existing in the external
environment of a business which are beyond the control of
the business but has direct influence on its performance.
4.2.7
QUESTION NO 11
Does financial ratio help to unravel the mass of truth
hidden in financial statement?
94
TABLE 4.8 FINANCIAL RATIO IN UNRAVEL THE MASS OF
TRUTH THAT WAS HIDDEN IN FINANCIAL STATEMENT.
Response
Mgt, staff
Non-mgt staff
Yes
5
25% 14
70%
NO
0
0% 1
5%
Total
5
25%
15
75%
Total
19
95%
1
5%
20
100%
SOURCE: QUESTIONNAIRE
From the table 4.6 above it show’s that all the mgt, staff
agreed that financial ratio help to unravel the mass truth hidden
in the financial statement while 14 (70%) of the Non mgt staff
also agreed bringing a total of 19 (95%) of the respondent
disagree with that fact.
95
CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1 INTRODUCTION
This
chapter
concludes
the
project.
It
contains
the
summary of the research findings, the conclusion, and the
recommendations offered by the researcher based on the
findings.
5.2 SUMMARY AND DISCUSSION OF FINDINGS
With particular reference to the organization under study as
well as the literature review, the research are summarize and
discussed as follows:
1.
Ration
analysis
facilitates
proper
understanding
of
information continued in financial statements and aids business
decisions. According to Essien (2006:11), “financial statements
carry lots of financial statements become more useful when they
are related each other or to some other relevant financial data by
means of rations.”
2.
Financial rations are useful in evaluating and predicting the
performance and financial position of a business, as well as
identifying areas that need improvement. Norbert f. Lindsborg of
Harold
Washington college (in Dansby et al, 2000: 181)
96
observed: “ As an investor in a corporation or as owner or manger
of a business, you are naturally interested in knowing how well
the firm is doing financially. You will want to compare this year’s
is available to pay bills in the near future.
3.
despite the obstacles to the proper use of financial ratios,
there are helpful suggestions on ways to enhance efficient use of
ratio
analysis
in
decision-making.
According
to
Lasher
(1997:69,82); “although ratio analysis is a powerful tool, it has
some significant shortcomings. Analysis have to be careful not to
apply the techniques blindly to any set of statements they come
across, due to differences in business and accounting methods.
Hermason et al. (1992:846), “financial analysis relies
heavily on informed judgment. Percentages and rations are
guides to aid comparison and useful in uncovering potential
strengths and weaknesses.
However, the financial analysis
should seek the basic causes behind and established trends”.
4.
Financial rations need to be carefully computers and used
with the right yardsticks of comparison in order to of optimal
benefit to the users. In this regard, Omuya (1983:456),
“Interpretation of a change in a ratio needs careful examination
of changes in both numerator and denominator. Without very full
97
and detailed investigation some wrong
conclusion can as
drawn.”
5.3 RECOMMENDATIONS
With reference to the findings of the study, the researcher
recommends the following:
1.
Users of financial statements need to have at least, a fair
knowledge of accounting so as to enable then understand and
appreciate accounting information.
2.
Prospective investors should properly analyze the financial
statements of companies before deciding to invest in the
companies.
3.
Users of financial statement who are not knowledgeable
enough to analyze or understand the information contained in
them should seek the services of qualified financial analysts,
accountants, stockbrokers, bankers, etc.
4.
In view of the remarkable influence which accounting
informations have on the decisions of the users, it is pertinent
that only qualified and honest persons should and audit financial
statements.
5.
Financial rations should be used with careful examination
and proper understanding of the meaning, implication and effect
98
of the actual figures shown in financial statements, in order to
avoid making wrong judgments, conclusions and decision.
6.
financial ratios should be judiciously used by firms,
investors,
lenders,
shareholders,
managers,
and
other
stakeholders, in view of their numerous benefits and limitations.
5.4 CONCLUSION
Financial
statements
contain
lots
of
information
summarized in figures. Viewed on the surface, they do not
provide enough information about the viability of the reporting
entity. Thus, they need to be analyzed by means of financial
ratios to unravel the mass of truth hidden in them, and to
enhance decision-making.
Ratio analysis helps to reveal, compare and interpret salient
features of financial statements. When applied to a set of
financial statements, financial ratios highlight significant aspects
of the financial position and operational results of a business
requiring
further
investigation.
They
help
to
identify
the
strengths and weaknesses of a business.
In
fact,
ratio
analysis
helps
to
evaluate
the
past
performance, the present condition, and the future prospects of a
business. It enables us to ask the right questions about a
99
business, and paves way to finding the useful answers. Such
analysis therefore, aids planning, control, forecasting and
decision- making.
100
REFERENCE
Dansby, Robert L., Burton S. Kaliski, & Michael D. Lawrence.
(2000).
Paradign College Accounting.
Ed St. Paul, MN:
Paradigm Publishing Inc.
Essien, Eniefiok E. (2006).
Entrepreneurship: Concept and
Practice Uyo: Abaam Publishing Co.
Hermanson, Roger H. James Don Edwards, & Michael W. Maher.
(1992). Accounting Principles 5th ed. Boston, MA Richard D.
Irwin, Inc.
Lasher, William R. (1997). Practical Financial Management St.
Paul MN: West Publishing Company.
Needles, Belverd E. et al. (1996). Principles of Accounting. 6th ed.
Boston. Houghton Miffin Company.
Omuya, J.O. (1983). Frank Wood’s Business Accounting. West
African ed. Volumes 1 & 2. London: Longman Group Ltd.
101
BIBLIOGRAPHY
Akpakpan, Bassey A. (2000). Accounting for Beginners: An
introduction to financial Accounting. Part1. (2005). Guide
line on project writing: introducing students to the search
through
practical
Approach.
Revives
ed.
Uyo:
Abaum
Publishing co.
Ayandele, I.A.(2005), Quantitative techniques for managerial
Decisions, Ugo: Cle-print publishers.
Bittel, lester R, Ronald s. Burke and Lawrence R. Lanf orge.
(1984). An Introduction to business: Business in Action 2nd
ed. New York: Mc Graw Hill Book company.
Dansby, Robert l., Burton s. Kaliski, annd Michael D. Lawrence.
(2000). Paracligin college Accounting. 4th ed. st paul,mN:
paradigm publishing Inc.
Essien, Enefiok E. (2006). Entrepreneurship concept and
practice, uyo: Abaem publishing co.
Hermanson, Roger H., James Don Edwards and Michael
W.Maher (1992). Accounting principles. 5th ed. Boston, MA:
Richard D. Irwon, Inc
Hoel, P.G. (1984). Introduction to mathematical statistics. 4th
ed. new York: john Wiley and song Int.
102
Hornby,
A.S.,
et
al,
(2000).
Oxford
Advanced
learner’s
dictionary. 6th ed. oxford:” oxford university press.
Igben,Robert O. (1999). Financial Accounting made simple.
Lagos: Rol publishers.
Ikon, Michael A. (2004). An Introduction to Business in the
Nigerian Environment. Onitsha: Nigeria publishers.
Inanga, Eno l. (1990). Principles of Accounting 2nd ed. Ibadan:
Heineman Educational Books Plc.
Lasher, William R. (1997). Advanced financial Accounting. 5th
ed. London: pitman publishing co.
Mc Shane, steven L. and Mary Ann vin Glinow (2000)
organizational Behaviour. Boston: Irwon Mc Graw Hill.
Needles, Belverd E. et al. (1996). Principles of Accounting. 6th
ed. Boston: Houghton Miffin company.
Nsini, K.M. AND N.S. Udoh. (2000). An introductory statistics.
Uyo: Omniscient printing press.
Nwachukwu, Vitalis O. and Kelechi G Egbolonu. (2000)
Elements of statistical inference. Owerri: peace Enterprises
Ltd.
Okezie, B.N. (2002). Fundamentals of financial Accounting.
Owerri: BON publications.
103
Omuya, J.O. (1983). Frank Wood’s Business Accounting. West
Africa ed. volume I and 2 London Long man Group Ltd.
Osuala, E.C. (1987). Introduction to Research Methodology. 2nd
ed. Onitsha: Africana-feb publishers Ltd.
104
APPENDIX I
RESEARCH
QESTIONNAIRE
ON
“THE
ROLE
OF
RATIO
ANALYSIS IN BUSINESS DECISIONS: A CASE STUDY OF O.JAIO
BROS, ENT (NIG) LTD. ABA, ABIA STATE.
RESPONDENTS: Management and staff of O, Jaco Bros, Ent.(nig)
ltd, Aba, Abia State.
INSTRUCTION: Please tick [√] the appropriate answer or fill the
blank spaces where required.
1.
Your Sex:
(a) male
[ ]
(b) female [ ].
2.
Which position do you occupy on the organization?
(a)
Management staff [ ]
3.
Do you believe that financial statements- income statement
(b) Non management staff [ ]
and balance sheet are effective ways of communicating financial
information?
(a)
Yes [ ]
(b)
No
[ ].
4.
Is Ratio Analysis used by your firm as a decision making
tool?
(a)
Yes [
] (b)
No
[
].
5.What is the highest level of education that you obtained?
(a)
Msc [
] (b)
Bsc [
]
(c)
HND
[
]
105
(d) OND
[
6.
you
Do
] (e)
O Level
agree
that
[
ratio
].
analysis
facilitates
proper
understanding of information contained in financial statements?
(a)
Yes [
] (b)
No
[
].
7.
Do you think that Ratio Analysis is useful to management,
investing shareholders and creditors in their business decisions?
{a}
Yes [
] (b)
No
[
].
8.
Do you think that financial ratios are useful in evaluating
and predating the performance of a business as well as certifying
areas that require improvement?
{a}
Yes [
] (b)
No
[
].
9.
Do you agree with the saying that rotor analysis helps its to
ask the right questions but do not provide answers unless the
right comparative standards and techniques are used?
{a}
Yes [
] (b)
No
[
].
10. Are there obstacles to the proper use of rotor analysis in
your business clerisies?
{a}
Yes [
] (b)
No
[
].
10b If (10) above is “yes”, then state the obstacles?
11. Does financial retro helps to unravel the mass of truth
hidden in financial statement?
{a}
Yes [
] (b)
No
[
].
106