Accounting Department Research project Topic Chapter 1-5 titled – Appraise The Effectiveness Of Financial Ratios as a Tool For Measuring Financial Performance
CHAPTER ONE
1.1 INTRODUCTION
An important feature of a typical business organization is the separation of ownership from management, for instance, a limited liability company, it is therefore expedient for management to render stewardship accounts to the owners of the business organization for evaluating the performance of the organization as whole.
THE ORGANIZATIONS AS A WHOLE
The stewardship accounting, which is usually, called the financial reports: contain information that would aid users of such reports in their judgments or decisions about economic and financial matters, especially of the organization concerned. The information is expressed monetary terms.
When the absolute naira amount of most data items reported in the financial statements are considered individually, they are generally of limited usefulness. Significant relationship may not be apparent from a view point of absolute naira amount because no indication is given of whether a particular item is good or bad for the firm. In order to appreciate the users of the report frequently convert significant charges and relationship, the naira amount reported in the financial statement into percentages and ratios by the users of the report.
Therefore, a ratio is a measure used to describe the relationship between two figures which can be expressed as a percentage or a rate in quotient. Taken in isolation, a ratio is meaningless unless it is compared with other ratios and only then can draw some meaningful relationship arising from the picture presented by the rates.
Ratio analysis is therefore, described as the relationship between two or more financial data in the financial statement to aid the determination of the financial condition and performance of a firm. It is the interpretation of the balance sheet and income statement of a business organization.
It involves comparing of series of selected items with another series and relating the resultant figures (termed ratios) against standards.
Lucey (2008) defined ratio analysis as the systematic production of ratios from both internal and external financial report to summarize core relationship and outcomes for evaluating financial performance.
A number of ratios are computed to provide useful information to various interest groups having a stake in the organization. Baker (2006) observed that financial ratios assist in conducting spot check on the financial health of an organization. Diagnostically, ratios are used in combination so that a satisfactory outcome for one test is not sufficient to guarantee that all others will yield the same result. Accordingly, it is necessary to work systematically through a series of test before a clean bill of health can be issued.
Financial ratios, though mostly report on past performance, they can be predictive and provide indications of potentials problems areas. The effectiveness of financial ratios as a tool will always determine the quality of decisions made by managers and other users of financial information.
1.2 PROBLEM ANALYSIS
A number of obstacles constitute the research problem. In ratio analysis, the problems faced by company in measuring its financial performance were as follows:
- The management of the company is always faced with the problem of identifying the appropriate ratios to use in order to measure the performance growth of the company over a number of years.
- Another prominent financial related problem is the poor financial management, which continues to affect the ability to which a firm meets its short terms maturing obligations. Business organizations in Nigeria are always faced with the challenges of managing the finance (provided by the owners of the firms) efficiently.
This problem of poor financial management had caused havoc in the past, how will managers detect this problem before it escalates and what are the possible solutions to such problems?
- Banks and non – banks financial institutions are always faced with the need to extend credit facilities to viable client and to finance a project that is worthwhile. How can they fix precisely which client is viable enough to meet their demand or terms) however, to what extent can financial ratios be used as a tool that will assist financial institution in optimizing its objectives?
- Lastly, investors generally are faced with the problems of investing divesting or increasing their interest in a firm. Individuals and corporate investors ask question like: where should I invest? How many years will it take me to recoup my capital or initial outlay? How profitable is the investment?
1.3 OBJECTIVES OF STUDY
In as much as a research needs to be carried out to appraise the effectiveness of financial ratios as a tool for measuring financial performance, the objective of the study needs to be spelt out. The objective of this study includes the following:
- To ascertain how conversant or acquainted managers in business organizations are with financial ratios as a tool for measuring performance. Do managers know what financial ratios really are? Or is it that managers are not even aware that there is a tool like that for measuring performance?
- To identify the extent to which ratio analysis is of relevance in determining the efficiency and profitable of an organization.
- To understand the relative importance of ratio analysis in the financing and investing decision of a business organization. This is essential in order to know the effectiveness of the organizations credit and financing policies.
- To ascertain the importance of ratio analysis to external users in developing confidence in an organization.
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