You are on page 1of 85

1 THE ROLE OF RATIO ANALYSIS IN BUSINESS DECISIONS A CASE

2

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

3

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

4

well as return on their investments. 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

5

the past performance of a business by taking a look at the trend 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,

6

and credit and investment advisory services. 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

7

comparative financial data. The most widely used tools for this 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). computed as follows: The percentage change is

8

Percentage change =

Amount of naira change x100

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. computed as follows: Percentage increase = N540 thousand x 100 N4,838 thousand = 11.2% This was

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.

9

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 N’000 Fixed Assets(Net) 21,910 Current Assets: Inventory Cash 10,820 7,200 9,650 5,100 26,620 1,170 12.1 1,980 2,100 41.2 5,250 19.7 16.7 Accounts Receivable 13,850 11,870 2007 N’000 21,760 Increase % 0.1 150 (Decrease) N’1000

Total Current Assets 31,870

Total Assets N53,780 N48,380 N5,400 ======== ====== LIABILITIES & STOCK HOLDERS’ EQUITY Current Liabilities: Accounts Payable Dividends Taxation 6,800 1,200 640 6.020 610 780 30 =======

N11.2 ======

13.0 14.3 4.9 12.5 (2,080) (34.1)

1,050 150 7,680 960 6,100

Total Current liabilities 8,640 Long-term Liabilities: 8% Debentures 4,020

10

Total Liabilities Common Stock

12,660

3,780

(1,120)

(8.1)

Stockholders’ Equity: (N1par,Quoted at N1.20) 20,460 Retained Earnings Total Liability & Stockholders’ Equity N53,780 ===== === 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 commonsize 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 N48,380 N5,400 11.2 ===== ====== 20,660 16,900 17,700 3,560 2,969 21.1 16.7

11

the performance of a firm with its own history (to identify important 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.

12

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) Less Cost of Sales: Opening Inventory Add Purchases Less Closing Inventory Cost of Sales Gross Profit Less Operating Expenses Income from Operations Less Interest Expense Income before Taxation Less Income Taxes Net Income Dividend Retained Earnings 9,650 38,670 48,320 10,820 37,500 35,300 19,513 15,787 680 15,107 6,043 9,064 2,650 6,414 ===== 3.3 53.1 66.4 14.9 51.5 48.5 26.8 21.7 0.9 20.8 8.3 12.5 3.6 8.8 === 10,020 33,230 43,250 9,650 33,600 31,100 17,564 13,536 730 12,806 5,122 7,684 2,500 5,184 ==== 15.5 51.3 66.8 14.9 51.9 48.1 27.1 20.9 1.1 19.8 7.9 11.9 3.7 8.0 == 72,800 % 100.0 2007 N’000 64,700 % 100.0

13

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% Hermanson et al. (1992:829) observed: “trend

14

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(%) RATIO ANALYSIS Dansby et al. (2000:845) defined ratio as “fractional relationship of one number to another”. Needles et al. On the other hand, 2007 2006 2005 2004

72,800 64,700 58,900 52,400 50,800 143.3 127.4 115.9 103.1 100.0

(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. Ratios are guides or shortcuts that are useful in evaluating a company‘s financial position and operations and making

15

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 longterm financial obligations. (2) The riskness or long-term solvency of a business. That is,

the level of gearing or leverage or the extent the firm is

16

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 a time and shows how it is possible to draw tentative conclusions by comparing the result of the ratio with some

17

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. 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

18

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. 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 It is the primary measure of a

current liability there must be a minimum of N2 current assets to cover it. This standard is often used by lending institutions 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

19

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 8,640 = 3.7:1 2007 26,620 7,680 = 3.5:1

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 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.

20

(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 31,870 8, 640 = 3.7:1 2007 26,620 7,680 = 3.5:1

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 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,

21

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 31,870 – 10,820 8,640 = 2.4:1 2007 26,620 – 9,650 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 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.

22

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. 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

23

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 15,787 X 100 = 21.1% 72,800 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 nonoperating expenses. Net profit margin can be calculated as follows: Net Profit Margin = Net Income Net Sales X 100 2007 13,536 X 100 64,700 = 20.9%

24

For Toptree Company, Net profit Margin = 2008 9,064 72,800 X 100 = 12.5% 2007 7,684 X 100 64,700 = 11.9%

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.

RETURN ON OPERATING ASSETS This measures the Profitability of a business in carrying

25

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 = 29.3% 2007 13,536 48,380 = 28.0% =

RETURN ON TOTAL ASSETS Return On Total Assets quantifies the success of the

26

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 9,064 X 100 = 16.9% 53,780 2007 7,684 X 100 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 Capitals Employed (ROCE) or Return On Investment (ROI) because it shows proportion of capital employed, stockholders

27

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 9,064 X 100 = 22.0% 41,120 2007 7,684 X 100 = 22.2% 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 Collection period for Accounts Receivable, Total Assets Turnover, and Fixed Assets Turnover.

28

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

29

For Toptree, Inventory Turnover 2008 37,500 = 3.7times

= 2007 33,600 = 3.4times

(9,650+10,820)/2

(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 = 98.6 days 2007 365 days 3.4 From the above computations, it could be understood that = 107.4 days =

30

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.).

31

Therefore, for Toptree, Accounts Receivable Turnover 2008 72,800 13,850 = 5.3 times 2007 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

32

Accounts Receivable Turnover For Toptree, ACP 2008 365 days = 5.3 68.9 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) = 2007 365 days = 66.4 days

33

Investments are excluded from the formular since they are not intended\ to produce sales. (Dansby et al., 2000:834). In 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 72,800 53, 780 = 1.4 times = 2007 64,700 48,380 =1.3times

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

34

being generated from each naira invested in fixed assets may indicate over capacity, poorer-performing equipment, or under utilization of fixed assets. FAT can calculated as follows: FAT = Nest Sales Average fixed Assets For Toptree, Fat 2008 72,800 21,910 = 3.3 times = 2007 64,700 21,760 = 3.0 Times

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

35

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. 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.

36

(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. Debt ratio calculated as follows: Debt ratio = Total Liabilities x 100

Total Assets For Top tree, the debt ratio 2008 2,660 x 53,780 100 = 23.5% = 2007 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.

37

Equity Ratio can be calculated as follows: Equity Ratio = Stockholders’ Equity x 100

Total Assets

38

For Top tree, Equity Ratio 2008 41,120 x 100 = 76.5% 53,780 Debt-To-Equity Ratio

= 2007 34,600 x 100 = 48,380 71.5%

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 = 3.2:1 2007 34,600 13,780 = 2.5:1 =

Form the above results, it is obvious that Top tree’s debt-

39

equity 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

40

For Top tree, leverage Ratio 2008 4,020 41,120 = 0.1:1

= 2007 6,100 34,600 = 0.2:1

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 21,910 4,020 = 5.5:1 2007 21,760 6,100 = 3.6:1

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

41

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 = 23.2 times 730 From the above computations, it is apparent that Top tree has a very strong and improving interest coverage ratio and is = 2007 13,536 = 18.5times

42

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 = 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 conditions. FCC can be calculated as follows: FCC = Income from operations + Lease Payments that must be made regardless of business Income from operations +

43

Interest

+

Lease Payments

44

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 2008 15,787 + 740 = 11.6 times 680 + 740 2007 13,536 + 720 = 9.0 times 730 + 720 FCC =

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.

45

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 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 Number of Ordinary Share

Average number of common stock outstanding For Top tree, EPS = 2008 9,064 20,460 = N0.44 2007 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

46

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, 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 1.20 = 0.44 2.7 times 2007 1,18 = 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 2.6 times

investment. It is inverse of P/E ratio expressed as a percentage.

47

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:

48

Earnings Yield =

EPS

x

100

Market price per share Or 1 P/E For Top tree, earnings Yield 2008 0.44 x 100 = 36.7% 1.20 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 2007 0.45 x 100 = 38.1% 1.18 = x 100

Number of common stock outstanding

49

For Top tree, DPS 2008 2,650 20,460 =

= 2007

N0.13

2,500 16,900

=

N0.15

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 EPS For Top tree, DPR = 2008 0.13 x 100 0.44 % = 29.5% 2007 0.15 x 0.45% 100 = 33.3% 100

50

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 0.13 x 1.20 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: 100 = 10.8 % = 2007 0.15 x 100 1.18 = 12.7%

51

Dividend Coverage= Net Income or Profit after tax &preferred Dividend Dividend Dividend on Ordinary Shares

For top tree, Dividend coverage = 2008 9,064 2,650 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: = 3.4 times 2007 7,684 2,500 = 3.1 times

Market to Book Value Ratio

=

Market Price Per Share

52

Book Value Per Share Or market price per share Equity (Number of shares outstanding) For Top tree, Market to Book Value Ratio = 2008 1.20 = (41.120) (20,460) 0.6 2007 1.18 (34,600) (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 Corporation are called Du pont Equations (DPEs). (Lasher, 1997:80).

53

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: ROA = Net Income Total Assets x Sales Sales

54

Reversing the order of the denominator: ROA = Net Income Sales That is, ROA = ROS X x Sales Total Assets 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 9,064x72,80 x 100 = 16.9% 72,800 53,780 2007 7,684 x 64,700 x 100 = 15.9% 64,700 48,380

The second but extended Du pont Equation is developed by writing the definition of ROE and multiplying sales/sales and

55

by total assets/total assets. The equation is stated as follows: ROE = Net Income Equity x Sales x Total Assets

Sales

Total Assets

Re-arranging the denominators: ROE = Net income Sales That is, ROE =ROA x Then, ROE = x Sales Sales Equity Multiplier. x Total Assets Equity

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 words, the way you finance a business can greatly exaggerate the results of “nuts and bolts” operations. (Lasher, 1997:81).

56

For Top tree, ROE (using the Extended Du pont Equation) = 2008 9,064x 72,800 x 53,780 x 100 100 72,800 53,780 41,120 = 22.0% 64,700 48,380 34,600 = 22.2% 2007 7,684x64,700x48,380x

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 Top tree Company Industry Average 16.9% 19.3% = ROS 12.5% 5.5% X TAT 1.35 X 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. The turnover problem is probably in one or both of two

57

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 goodwill, preference shares, and research and

58

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 1997:82,83). 3. Window Dressing: In a deliberate attempt to make can badly distort true results. (Lasher,

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

59

measure of adequacy. Thus, past performance may not be enough to meet present needs and make reliable projections. 5. size, Uniqueness Of Companies: Every Company is unique in 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, quantitative financial ratios provide omits only quantifiable or or

information

and

non-quantifiable

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 accepted standards, norms or yardsticks for

universally

comparison. Standards are used in accordance with industry,

60

firm, circumstance and objective pursued. For instance, the rule-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.

61

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.

62

CHAPTER THREE RESEARCH METHODOLOGY 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. 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 information sources i.e. of data collection was are first by hand the

information

that

gathered

researcher himself directly from the respondents. In this

63

regains, questionnaire and oral interviews were used to collect the requisite data from the 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

64

management staff. 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= 27 1 + 27 (0.05) 2 n= 27 1 + 27 (0.025) (a constant) level of significance ((e) = 0.05)

65

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

66

questionnaires to the respondents.

67

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.

68

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.

69

TABLE

4.1

QUESTIONNAIRE

DISTRIBUTIONS

AND

COLLECTION Staff position Administered Mgt, Staff 5 20% Non-Mgt. staff 20 Returned Not returned 5 20% 0 0% 15 60% 5 20%

80% Total 25 100% 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.

4.2.1 QUESTION NO 5

70

What is the highest education qualification level obtained? TABLE 4.2 HIGHEST EDUCATION QUALIFICATION LEVEL OBTAINED Level Msc Bsc Hnd Ond O level Total Mgt. Staff 1 5% 2 10% 2 10% 0 0% 0 5 0% 25% Non mgt. staff 0% 0% 6 30% 7 35% 2 15 10% Total 1 2 8 7 2 20 5% 10% 40% 53% 10% 00%

75% 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.

4.2.2 QUESTION NO 6 Do you agree that Ratio Analysis facilitates proper understanding of information contained in financial

71

statements? TABLE 4.2 RETIO ANALYSES AS A FACILITOR OF PROPER UNDESTANDING OF FINANCIAL STATEMENTS Responses Mgt. Staff Non-mgt. Total 75% 20 0% 0 75% 20 100% 0% 100%

staff Yes 5 20% 15 No 0 0% 0 Total 5 20% 15 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 Do QUESTION NO 7 you think that Ration Analysis is useful to

management, investors, shareholders and creditors in their business decisions?

72

TABLE

4.4

USEFULNESS

OF

RATIO

ANALYSIS

IN

BUSINESS DECISIONS. Responses Mgt. staff Non staff 13 2 15 mgt. Total 65% 18 10% 2 75% 20 90% 10% 100%

Yes 5 25% No 0 0% Total 5 25% 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?

73

TABLE 4.5 USE OF FINANCIAL RATIOS IN EVALUATION AND PREDICTION OF BUSINESS PERFORMANCE Responses Mgt. staff Non staff 12 3 15 mgt. Total 60% 15% 75% 17 3 20 85% 15% 100%

Yes 5 25% No 0 0% Total 5 25% 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 Yes No Total Mgt. staff 5 25% 0 0% 5 25% Non-mgt.staff 10 50% 5 25% 15 75% Total 15 75% 5 25% 20 100%

74

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, 70% 5% 75% Total 19 1 20 95% 5% 100%

staff Yes 5 25% 14 No 0 0% 1 Total 5 25% 15 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.

QUESTION NO 10b (ANSWER)

75

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?

76

TABLE 4.8 FINANCIAL RATIO IN UNRAVEL THE MASS OF TRUTH THAT WAS HIDDEN IN FINANCIAL STATEMENT. Response Mgt, staff Yes 5 25% NO 0 0% Total 5 25% SOURCE: QUESTIONNAIRE Non-mgt staff 14 70% 1 5% 15 75% Total 19 1 20 95% 5% 100%

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.

CHAPTER FIVE SUMMARY, CONCLUSION AND RECOMMENDATIONS 5.1 INTRODUCTION

77

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)

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

78

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 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 accounting

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 and detailed investigation some wrong conclusion can as drawn.”

79

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 of the actual figures shown in financial statements, in order to avoid making wrong judgments, conclusions and

80

decision. 6. financial ratios should be judiciously used by firms, lenders, in shareholders, of their managers, numerous and benefits other and

investors,

stakeholders, limitations.

view

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

81

business, and paves way to finding the useful answers. Such analysis therefore, aids planning, control, forecasting and decision- making.

82

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.

83

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: (b) female [ ].

(a) male [ ] 2. (a) 3.

Which position do you occupy on the organization? Management staff [ ] Do you believe that (b) Non management staff [ ] financial are statementseffective income ways of

statement

and

balance

sheet

communicating financial information? (a) 4. tool? (a) Yes [ ] (b) No [ ]. Yes [ ] (b) No [ ].

Is Ratio Analysis used by your firm as a decision making

5.What is the highest level of education that you obtained?

84

(a)

Msc [ [

] (b) ] (e)

Bsc [ O Level

] (c) HND [ ].

[

]

(d) OND 6.

Do you agree that ratio analysis facilitates proper of information contained in financial

understanding statements? (a) 7. Yes [ ]

(b)

No

[

].

Do you think that Ratio Analysis is useful to management, shareholders and creditors in their business

investing decisions? {a} Yes [ 8.

] (b)

No

[

].

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 [ 9. ] (b) No [ ].

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 [ ].

85

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 [ ].