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1.1 Background of the study
Financial information is an essential ingredient for decision making within and outside the organization. Hence every organization (profit and non-profit) that source and utilize funds must of a necessity prepare a statement of account showing detail analysis of movement of funds within the organization during a particular period of time. This information is usually contained in the firm’s financial statements (profit/loss account and balance sheet) shows the true position of the firm as at a particular date and this will assist all relevant stakeholders to gain insight into the operation and performance of the firm. One important goal of the accountant is to report financial information to the user in a form useful for decision making. Most of the language of financial management is rooted in the financial statements.
The financial statements of a firm consist of three main accounts; the balance sheet, the profit and loss account, and the cash flow statements. The balance sheet shows the financial position and accounting value of a firm at a particular date. As a snapshot of the firm, it is a convenient means of organization and summarizing what a firm owns (its assets), what a firm owes (its liabilities), and he difference between the two (the firm’s equity) at a given point in time. The profit and loss account shows the results of operation of this firm over a particular accounting period. The cash flow statement provides information about cash inflows and outflows during an accounting period and separate cash flows into operating activities, investing activities and financing activities. This statement is usually included in a financial statement just to provide additional information that will helps stakeholders in gaining insight into the financial statements. The main components of financial that constitute our analysis and interpretation of financial information of any business organization are the balance sheet and profit and loss account.
Financial analysis is the process of identifying the financial strengths and weaknesses of the firm by properly establishing relationships between the items of the balance sheet and the profit and loss account. Financial analysis can be undertaken by management of the firm, or by parties outside the firm, owners, creditors, investors and others (Foster, 1986). One important tool for financial analysis is ratio.
Financial ratio is the relationship between two or more financial data usually expressed as a percentage or in relation to another figure or group of figures in the same financial statement. These ratios are ways of comparing and investigating the relationships between different pieces of financial information. It is also used as a benchmark for evaluating the financial position and performance of a firm. The absolute accounting figures reported in the financial statements do not provided meaningful understanding of the performance and financial position of a firm, such information only conveys meaning when it is quantitatively compared and related to some other relevant information through ration analysis.
The methods are based on tried and true accounting ratios, which have been around for even longer. The theory of financial ratio analysis was first popularized by Benjamin Graham who is considered by many to be the father of fundamental analysis. Benjamin Graham, who from 1928 was Professor at Columbia Business school as well as a very successful investor in his own right, was mentor and teacher to Warren Buffett.
Fundamental analysis, of which financial ratio analysis is but one subset, looks at a company’s financial statements, management, health and position in the competitive landscape to determine a share price valuation. It is different from the other commonly used methods of investment analysis – quantitative analysis and technical analysis – in that it looks from the bottom-up rather than from the top down, or – in the case of technical analysis – from what the charts say:
Performance evaluation of a company is usually related to how well a company can use its assets, shareholder equity and liability, revenue and expenses. Financial ratio analysis is one of the best tools of performance evaluation of any company. In order to determine the financial position of a firm, fundamental analysis and financial ratio analysis must form the basis of all investment decisions, because without knowing the true financial position of a company you are purely speculating.
1.2 STATEMENT OF THE PROBLEM
Although financial accounting statements shows the financial positions of a business at the end of a financial period, but they do not present accurate performance on the level of performance or efficiency of operations of a business at the end of financial period.
It is usually observed that the operating profit figure of a company might be higher in the current year than the previous year but his higher profit figure cannot be used to say the company has performed better in the current year than in the previous because the cost of the asset is being considered in all the beginning of that first year which may reduce the profit for that period.. If this is judge based on this, it will have adverse or negative impact on the investment or investors.
Many investors in Nigeria are uneducated or illiterate and as a result of ignorance or inexperience, they cannot use or employ financial ratios in evaluating the performance of the companies. Also existing shareholders use the cash dividends and interest paid to them in evaluating the performance of the companies for investment decision. These parameters do not give accurate information about the performance and efficiency of operation of the companies. Some managers do not employ financial ratios in performance appraisal and in the evaluation of investment decision because of technicalities involved in financial ratio analysis, fear of assessment and in experience. Therefore, they make use of other alternatives inside of using financial ratios. Because of all this problems, the research work will go or examine they importance or usefulness of financial ratios in evaluating of companies performance for investment decision. Every benefits derived from financial ratio will be examined for proper investment decisions.
1.3 PURPOSE OF THE STUDY
The objectives of this study are;
Assessing the firm’s performance and profitability;
1. To examine the impact of financial ratios on investment decision.
2. To examine the relationship between financial ratio analysis and SWOT analysis.
3. Examine the indictors for investment in companies their earning performances, liquidity, positive economic soundness.
1.4 STATEMENT OF HYPOTHESIS
The hypothesis below would be subjected to testing Null Hypothesis
H0: The use of financial ratios has negative impacts on investment decision
H1: The use of financial ratios has positive impacts on investment decision.
H02: there is no significance relationship between financial ratio analysis and SWOT analysis
H2: there is a significance relationship between financial ratio analysis and SWOT analysis
1.5 SINGIFICANCE OF STUDY
This study will be very important to the following
1. PROSPECTIVE INVESTORS IN COMPANIES: It will enable them determine risks of investment in companies ie financial position of the companies thereby making them to invest in a company that will be profitably to them.
2. MANAGEMENT OF COMPANIES: It provided tool for assessing or evaluating the companies’ performance and also taking decision on where to invest.
3. GOVERNEMT: It helps the tax board to know the amount that will be taxed on companies’ profit.
4. EXISTING INVESTORS IN COMPANIES: after analyzing the performance of the company, it will help the existing investors to know whether to continue their investment or withdraw their interest
1.6 SCOPE AND LIMITATION OF STUDY
The research work will concern or effect only profit making organization. Public corporations are not treated in the study. The researcher encountered some constraints which include but are not limited to;
a) AVAILABILITY OF RESEARCH MATERIAL: The research material available to the researcher is insufficient, thereby limiting the study
b) TIME: The time frame allocated to the study does not enhance wider coverage as the researcher has to combine other academic activities and examinations with the study.
c) Finance: Limited Access to the required finance makes it difficult to get all the necessary and required information concerning the activities.
1.7 OPERATIONAL DEFINITION OF TERMS
ASSET: Economic resources owned by a business, which are expected to benefit future operation. It is divided into two
a. Fixed asset eg building, Equipment etc.
b. Current assets eg cash at hand, bank stock debated.
LIABILITIES: These are debts or obligations of a business organization. The claims of creditors against the asset of a business eg. Creditors, bank overdraft.
DIVIDEND: A distribution of cash by a company or corporation to its stockholders after allowable deduction have been made and appropriate to reserves. This benefit derived from the shareholders because of their interest in the company.
BALANCE SHEET: It is a financial statement, which shows, the financial position of a business entity of a business (balance sheet and income statement). It comprises of balance sheet, profit and loss account, note to the account, value added statement sources and application of funds.
PROFIT AND LOSS ACCOUNT: This is the record of business transaction of a company for a given period of time usually one year.
LEVEL OF LEVERAGE: This is the ratio of debt finance (i.e fixed interest borrowing) to the equity finance in a company’s capital outlay.
WORKING CAPITAL: This can be defined as the difference between the current assets and current liability i.e current asses less current liabilities.
CURRENT LIABILITIES: These are debts or claim which are payable within one year eg trade creditors overdraft.
CURRENT ASSETS: They are cash plus assets that are expected to be collected in cash or sold or consumed within the next year or as a part of the company’s normal operating cycle eg. Cash stock prepaid expenses.
RATIO ANALYSIS: This involves the companies of one figure aginst another to produce a ratio and assessing whether the financial ratios indicate weakness or strength in the company’s affairs.
HYPOTHESIS: This is proposition assumed to be true for purpose of argument. It requires testing before it can be accepted.
SECURITIES: These are financial asset of a company, which are sold do investors, which could attract returns or benefit on investment. Example are stocks, bonus etc.
LIQUIDITY: This is state of posing liquid asset such as cash and other assets that will soon be converted into cash.
COMPARATIVE FINANCIAL STATEMENT: Present the same company’s financial statements for two or more successive period in side by side column.
HORIZONTAL ANALYSIS: Analysis of a company’s financial statements for two or more successive period showing percentage and or absolute changes from previous year. The type of analysis helps detect changes in a company’s performance and highlight trend.
VERTICAL ANALYSIS: This type of analysis is the study of a single financial statement in which each item is expressed as a percentage of significant total for example of sale calculation.
NON-OPERATING ASSETS: Assets owned but used in producing revenue.
PERIODICITY: An assumption that an entity’s life can be subdivided into time periods such as months or years.
PROFITABILITY: Ability to generate income the income statement reflect a company’s profitability.
SOLVENCY: Ability to pay debts as they become due.
TRANSACTION: Record able happening or event that affect assets, liabilities stock holder’s equity revenue or expenses of an entity.
ORGANIZATION OF THE STUDY
This research work is organized in five chapters, for easy understanding, as follows. Chapter one is concern with the introduction, which consist of the (background of the study), statement of the problem, objectives of the study, research questions, research hypotheses, significance of the study, scope of the study etc. Chapter two being the review of the related literature presents the theoretical framework, conceptual framework and other areas concerning the subject matter. Chapter three is a research methodology covers deals on the research design and methods adopted in the study. Chapter four concentrate on the data collection and analysis and presentation of finding. Chapter five gives summary, conclusion, and recommendations made of the study.
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