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Small and Medium-sized Enterprises (SMEs) play an important role in any economy through generation of employment, contributing to the growth of Gross Domestic Production (GDP), embarking on innovations and stimulating of other economic activities. The objective of the study was to establish the financial reporting and ratio analysis practices adopted by small and medium enterprises in Akwa Ibom State and to establish the relationship between financial reporting and analysis practices and financial performance of small and medium enterprise in Akwa Ibom.
The study adopted a descriptive cross-sectional research design. The target population comprised of 100 SMEs in Akwa Ibom. The researcher used simple random sampling to select 50 respondents. Primary data is information gathered directly from respondents and for this study the researcher used questionnaires. Quantitative data collected was analysed by the use of descriptive statistics using SPSS and presented through percentages, means, standard deviations and frequencies.
The study found that there is a strong positive relationship between financial reporting, financial analysis, financial management and management accounting and financial performance of SMEs. There is need for management of Small and medium enterprise in Akwa Ibom to enhance their financial reporting practices, financial analysis practices ,financial management practices and management accounting practices as it was found that financial reporting and analysis practices affects the financial performance of small and medium enterprises in Akwa Ibom.
1.1 BACKGROUND TO STUDY
The purpose of preparing the financial statements of a company is to convey information on the overall performance and the state of affairs of such an organisation to all interested parties. Besides, users of these financial statements in such a way as to reveal the financial strengths and weaknesses of such an organisation in order to form an opinion as regard her going-concern. However, ratio analysis is one of the ways through which the financial statements could be interpreted. While ratio analysis is also a method used by financial managers and investors alike to compare a company’s financial structure, conditions and performances with standards prevailing in such industry for the purpose of high-lighting improvement or deterioration in the trend of the business performance. Lucey (1988) defined ratio analysis as the systematic products of ratios from both internal and external financial reports so as to summarize key relationships and results in order to appraise financial performance.
More so, ratio analysis could serve as a practical means of monitoring and improving performance and it could be enhanced when:
i. Ratios are prepared regularly and on a consistent basis so that trends can be highlighted and changes investigated.
ii. Ratios prepared for and individual firm can be compared with facilitated when the firm has ready access to comparative ratios prepared in a standard manner.
iii. Ratios are prepared showing the inter-locking and inter-dependent nature of the factors which contribute to financial success.
Nevertheless, ratio analysis utilizes figures that routinely appear in the financial statements for a period of several consecutive years, (that is 5years to 10years). One calculated, the ratio may be compare with external industry standards and with internal goals and budgets of the organisation in order to detect trends and estimates, improvement and stability of the measure conditions. Finally, it must be emphasized that ratios must be compared with some prevailing standards, because it cannot in itself convey any useful information.
Every firm is most concerned with its profitability. One of the most frequently used tools of financial ratio analysis is profitability ratio which is used to determine the company’s bottom line. Profitability measures are important to company managers and owner alike. If a small business has outside investors who have put their own money into the company, the primary owner certainly has to show profitability to those equity investors. Profitability ratios show a company’s overall efficiency and performance. Many researchers have studied the determinant of profitability in many ways. But none of them had studied on the determinant of profitability using financial ratio analysis. Because of this, researcher chose this research work to show how the financial ratio analysis can be used in determination of profitability in pharmaceutical industry. Nweze (2011) defines ratio analysis as financial statement analysis uses as a primary tool, ratios, which relate two figures applicable to different categories. Okwuosa (2005) sees ratio analysis is one number expressed in terms of another to show the relationship between them. He adds that in financial accounting and reporting, it is generally agreed that there are certain relationships between items shown in the profit and loss account and those in the balance sheet as well as between items in these statements. So ratios are used as a means of expressing these relationships. Ezeamama (2010) argues that ratios are most effectively used in interpretation of financial statement when compared to a standard or norm. A single ratio in itself does not indicate favourable or unfavourable condition. It has to be compared with a benchmark or standard before commenting on the ratio. Thukaram Rao (2009) states that ratio analysis is the process of determining and interpreting numerical relationship based on financial statements. It helps to summarise the large quantities of financial data and to make qualitative judgement about the firm’s financial performance. Osisioma (1996) says that analysis is the resolutions or separation of data into their elements or component parts, the tracing of facts to their source with a view to discovering the general principles underlying to individual phenomena. He continues that the analysis of financial accounts is therefore, the interpretation, amplification and translation of facts and data contained in the financial statements, the purpose being the drawing of relevant conclusions therefore, making inferences as to business operations, financial position and future prospects. Chandra (2008) adds that financial ratio analysis is a study of ratios between various items or groups of items in financial statement. Pandey (2010) sees financial analysis as a process of identifying the financial strengths and weaknesses of the firm by properly establishing relationships between the firm by properly establishing relationships between the items of the balance sheet and the profit and loss account. He adds that ratio analysis is a powerful tool of financial analysis. A ratio is used as a benchmark for evaluating the financial position and performance of a firm. So the relationship between two accounting figures, expressed mathematically, is known as a financial ratio (or simply as a ratio).
1.2 STATEMENT OF THE PROBLEM
Managerial decision is one of the keys to success in an organisation. And as such, management of a given organisation makes decision based on financial performances prevailing in such establishment. In arriving at such decisions, the management tries to focus their attention on two basics of comparison which are as follows:
Current performances are compares with the records of the part years in the organisation at least five (5) years period.
Current performances are compared with that attested performances in other similar organizations.
As a result of this exercise, in-estimable short comings may arise which could force management to take drastic steps/decisions that could make or mar the organisation. Also, problems may arise when an attempt is made to compare the ratio of one business with those of other organisation, and these could arise as a result of different accounting basis and the aftermath result could not be relied upon.
Moreover, problem(s) associated with effect of inflation are always being ignored and the resultant ratios are of limited value. As a result of the following, the use of financial ratios to appraise small scale business enterprise is the mainstay of this work.
1.3 OBJECTIVE OF THE STUDY
The broad objective of the study is to analysis how ratio analysis can be used to measure performance of an organisation. Also the following specific objectives will be examined in the course of this study:
i. To critically analyse the financial statement and evaluate the performance of the small scale enterprises through ratios to ascertain whether resource are optimally and efficiently utilized.
ii. To analyse the problems associated with the use of financial ratio analysis and proffer possible solutions.
iii. To identify the importance of financial ratio analysis to every use group.
iv. To analyse how financial ratio analysis can assist management to detect the various strengths and weaknesses of an organisation.
1.4 RESEARCH QUESTIONS
The following research questions shall be examined during this study:
i. Do you use financial ratios as a measurement of management performance?
ii. Does the management of this company apply financial ratio in making decisions that affect the company?
iii. Does ratio analysis help management in taking effective decisions?
iv. Do you agree that financial ratio reveal strengths and weaknesses of an organisation?
1.5 RESEARCH HYPOTHESES
The following hypotheses shall be tested during this research work:
H0: Financial ratios do not highlight the importance of effective management and appraisal of small scale enterprises.
H1: Financial ratios highlight the importance of effective management and appraisal of small scale enterprises.
1.6 SIGNIFICANCE OF STUDY
SMEs are actually the engine of economic growth. This sector provides employment opportunities, produces goods and services, and makes use of locally available resources including recycling of wastes thereby contributing in conserving the environment. Generally the users of SME financial reports might include banks and other creditors, the owners or shareholders and “others” (business advisors, tax authorities, trade contacts), (Sian & Roberts, 2009). The key beneficiaries of this study will be banks, micro-finance institutions, Government, and Non-governmental organizations that provide lending to the SMEs. All these need to structure a better way of rating the financial risks that face the SMEs they fund in order to get better loan repayment guarantees. The government will also benefit in form of increased taxes, GDP, and economic growth. The findings from this study will go a long way into establishing specific effects of financial reporting and analysis practices on SMEs. This information will be used to inform any efforts to train SME entrepreneurs.
1.7 Financial Performance of Small and Medium-sized Enterprises
According to Firer et al. (2004), the goal of financial management is to maximize the wealth of the owners of the firm. The goal of the firm is to maximize its value to its shareholders. Value is represented by the market price of the company’s common stock, which, in turn, is a reflection of the firm’s investment, financing, and dividend decisions. The market price of a firm’s stock represents the focal judgment of all market participants as to what the value is of the particular firm. It takes into account present and prospective future earnings per share, the timing, duration, and risk of these earnings, and any other factors that bear upon the market price of stock. The market price serves as a performance index or report card of the firm’s progress.
Osteryoung et al. (1997) argues that it is important to note that firms have stated or unstated objectives. Corporate finance theory assumes that the objective of the firm is to maximise shareholder’s wealth. This is, however, usually not the case with SMEs who often do not participate in the capital markets. Small business enterprises often exhibit differences in their objectives for running their businesses well away from the traditional shareholder wealth maximization concept. The objectives of small businesses include just having a job, enjoying a particular lifestyle associated with getting involved in a particular business, providing income to the owner-manager, and growing the business in terms of earnings through sales.
According to Kuratko et al. (1997), Woodlift et al. (1999) and Newby et al. (2003), the goal of SME owners can be measured quantitatively (financial) and qualitatively (non-financial). Financial return includes to earn as much profit as possible, to have as much disposable income as possible, to achieve financial security, to build family wealth for the future. Effective financial management strategy is crucial to the growth of a small business.
1.8 Financial Reporting and Ratio Analysis Practices and Financial performance of Small and Medium-sized Enterprises
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