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THE ROLE OF RATIO ANALYSIS IN BUSINESS DECISIONS A CASE 1
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Transcript of Ratio analysis in business decisions@ bec doms
THE ROLE OF RATIO ANALYSIS IN BUSINESS DECISIONS A CASE
1
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
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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.
3
Shareholders/Owners
The analysis helps shareholders or owners of a business to
ascertain the profitability of the operation of the business, as
well as return on their investments.
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)
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Assessment of past performance and current position, and (2)
Assessment future potential and related risks of a business.
Assessment Of Past Performance And Current Position
Financial statement analysis helps in assessing or judging
the past performance of a business by taking a look at the
trend 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.
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2.5 SOURCES OF INFORMATION FOR FINANCIAL
STATEMENT ANALYSIS
According to Needles et al. (1996:773), the major sources
of information about publicly held corporations are repots
published by the company, SEC reports, business periodical,
and credit and investment advisory services.
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
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example. Dun and Bradstreet corporation in USA offers an
annual analysis using fourteen rations of 125 industry groups.
2.6 TOOLS AND TECHNIQUES OF INDIANOLA
STATEMENT ANALYSIS
These are various methods and processes used to analyze
financial statements and show relationships and change among
comparative financial data. The most widely used tools for this
purpose are horizontal analysis, vertical analysis, trend
analysis, and ratio analysis.
HORIZONTAL ANALYSIS
This is a technique for analyzing financial statements that
involves the computation of changes in both (naira) amounts
and percentages from the previous to the current year.
(Needles et al., 1996:795). In horizontal analysis, the previous
year is always the base year in calculating the percentage
increase or decrease.
(Dansby et al., 2000:819). The percentage change is
computed as follows:
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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. This was
computed as follows:
Percentage increase = N 540 thousand x 100
N4,838 thousand = 11.2%
According to Hermanson et at. ( 1992 : 825), “ this type of
analysis helps detect changes in a company’s performance and
highlights trend.” Nevertheless, case must be taken in the
analysis of percentage changes, else they may result to a
distorted view or under estimation of the naira amount
changes.
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FIGURE 2.1 COMPARATIVE BALANCE SHEET WITH HORIZONTAL ANALYSIS
TOPTREE COMPANY LTD.COMPARATIVE BALANCE SHEETAS AT 31 DECEMEBER 2007 AND 31 DECEMEBR 2007 and 31 DECEMBER 2008 2008 2007 Increase (Decrease)ASSETS N’000 N’000 N’1000 %Fixed Assets(Net) 21,910 21,760 150 0.1Current Assets:Inventory 10,820 9,650 1,170 12.1Accounts Receivable 13,850 11,870 1,980 16.7Cash 7,200 5,100 2,100 41.2Total Current Assets 31,870 26,620 5,250 19.7
Total Assets N53,780 N48,380 N5,400 N11.2 ======== ======= ======
====== LIABILITIES & STOCKHOLDERS’ EQUITY Current Liabilities:Accounts Payable 6,800 6.020 780 13.0Dividends 1,200 1,050 150 14.3Taxation 640 610 30 4.9 Total Current liabilities 8,640 7,680 960 12.5Long-term Liabilities:8% Debentures 4,020 6,100 (2,080) (34.1)
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Total Liabilities 12,660 3,780 (1,120) (8.1)Stockholders’ Equity:Common Stock(N1par,Quoted at N1.20) 20,460 16,900 3,560 21.1Retained Earnings 20,660 17,700 2,969 16.7Total Liability &Stockholders’ Equity N53,780 N48,380 N5,400 11.2
===== ====== ===== ===
VERTICAL ANALYSIS
Dansby et al, (2000:846) defines vertical analysis as “the
expression of each item in a company’s financial statement as
a percentage of a base or total figure, in order to see the
relative importance of each item”. For Balance Sheet, the base
is total assets while for income Statement, the base is net
sales. According to Needles et al. (1996:784), the accountant
sets a total figure in the statement equal to 100 percent and
computes each component’s that results is called a common-
size statement as “financial statements that show only
percentage and not absolute { naira) amounts”.
Vertical analysis is useful for comparing the importance of
specific components in the operation of a business. It can also
be used in comparative common-size statements to compare
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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.
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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 2007
N’000 % N’000 %
Sales (Net) 72,800 100.0 64,700 100.0
Less Cost of Sales:
Opening Inventory 9,650 3.3 10,020 15.5
Add Purchases 38,670 53.1 33,230 51.3
48,320 66.4 43,250 66.8
Less Closing Inventory 10,820 14.9 9,650 14.9
Cost of Sales 37,500 51.5 33,600 51.9
Gross Profit 35,300 48.5 31,100 48.1
Less Operating Expenses 19,513 26.8 17,564 27.1
Income from Operations 15,787 21.7 13,536 20.9
Less Interest Expense 680 0.9 730 1.1
Income before Taxation 15,107 20.8 12,806 19.8
Less Income Taxes 6,043 8.3 5,122 7.9
Net Income 9,064 12.5 7,684 11.9
Dividend 2,650 3.6 2,500 3.7
Retained Earnings 6,414 8.8 5,184 8.0===== === ==== ==
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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%
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Hermanson et al. (1992:829) observed: “trend
percentages are used for comparison of financial information
over time to a base year or period’.
FIGURE 2.3 TREND ANALYSIS
TOPTREE COMPANY LTD
NET SALES TREND ANALYSIS
FOR THE FIVE YEARS ENDED 31 DECEMBER 2005
2008 2007 2006 2005 2004
Net Sales (N’000) 72,800 64,700 58,900 52,400 50,800
Trend Analysis(%) 143.3 127.4 115.9 103.1 100.0
RATIO ANALYSIS
Dansby et al. (2000:845) defined ratio as “fractional
relationship of one number to another”. On the other hand,
Needles et al. (1996:795) defined ratio analysis as “a
technique of financial analysis in which meaningful relationship
are shown between the components of financial statements”.
Ratio analysis is often expressed proportionately to show the
relationship between figures in the Financial statements. It is
the core of this study.
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Ratios are guides or shortcuts that are useful in evaluating
a company‘s financial position and operations and making
comparisons with results in previous years or with other
companies. The primary purpose of ratio is to point out areas
needing further investigation. They should be used in
connection with a general understanding of the company and
its environment. (Needles et at., 1996:786).
Thus, Lasher (1997:69) noted are most meaningful when
used in comparison. For that reason, it is difficult to make a
generalization about with a good or acceptable value is for any
particular figure. One measure alone does not tell the whole
story about a company and one measure should never be the
sole basis for a financial decision”. Hermanson et al.
(1992:840) added: “standing alone, a single financial ratio may
not be informative. Greater insight can be obtained by
computing and analyzing several related ratios for a company”.
2.8 USES AND OBJECTIVES OF RATIO ANALYSIS
Basically, ratio analysis is used in determining:
(1) The short-term and long-term liquidity of a firm or the
ability of the firm to meet its short-term (current) and long-
term financial obligations.
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(2) The riskness or long-term solvency of a business. That is,
the level of gearing or leverage or the extent the firm is
financed by debt.
(3) The Performance, profitability or overall earning power of
a business.
(4) The assets utilization or efficiency in the use of assets of a
business to generate sales revenue.
(5) The potential return and risk associated with owing shares
or investing in the stock a company.
2.9 TYPES OF RATIO ANALYSIS
Ratio analysis is divided into two types, namely; unviariate
ratio analysis and multi – variate ratio analysis. Meanwhile, for
the purpose of this study, the hypothetical Comparative
Balance Sheet and Income Statement of Toptree Company Ltd.,
shown in figure 2.1 and 2.2 respectively will be used to
illustrate these. Also, where a ratio calls for the use of an
average amount will be used where the beginning –of – year
amount is not available. (Hermanson et at., 1992:832).
2.9.1 UNIVARIATE RATIO ANALYSIS
This is the traditional and most popular approach to ratio
analysis used by accounting textbooks. It examines one ratio
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at a time and shows how it is possible to draw tentative
conclusions by comparing the result of the ratio with some
yardsticks of comparison. By studying a number of ratios in
this way, it is possible to piece together a picture of the
company’s performance and position. Lewis et al., 1996:375).
Owing to its role in achieving the objectives of ratio
analysis discussed earlier, univariate ratio analysis will be the
major focus of this study. Five of its categories to be discussed
include liquidity Ratios, Profitability Ratios, Assets Management
Ratios, Debt Management Ratios, and Investment Ratio.
LIQUIDITY (SHORT-TERM SOLVENCY) RATIOS
According to Dansby et at. (2000:826) “Liquidity is the
ability of a business to meet its financial obligations as they fall
due”. One the other hand, Needles et al. (1996 :787) defines
liquidity, as “a company’s ability to pay bills when they are due
and to meet unexpected needs of cash”.
Liquidity ratios can be divided into two – short-term
liquidity (solvency) ratios. However, for the purpose of this
study, liquidity Ratios refer to short-term liquidity ratios while
Debt Management Ratios refer to long-term liquidity ratios.
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Liquidity ratios (short-terms solvency ratios) are of
particular concern to short-term lenders and suppliers who
provide products and services to the firm on credit. They want
to be sure the company has the ability to pay its debts.
(Lasher, 1997:69). Liquidity Ratios include Current Ratio and
Quick or Acid Test Ratio.
Current Ration
This indicates the ability of a business to meet or pay its
short-term financial obligations or current liabilities out of the
current assets. Thus, it is also known as the ratio of current
assets to current liabilities. It is the primary measure of a
company’s liquidity.
A low current ratio may be an indication of a firm’s
inability to pay its financial obligations in the near future, while
a high current ratio may indicate excessive amount of current
assets or inefficient asset utilization by management.
The yardstick against which current ratio are measured is
the standard of 2 to 1 (2:1). This means that for every N1
current liability there must be a minimum of N2 current assets
to cover it. This standard is often used by lending institutions
18
and credit bureau and is generally considered as good.
(Dansby et al., 2000:827).
However, prospective creditors or lenders must take care
of sticking to this standard as a company may manipulate its
current ratio (by inflating inventory for instance,) in order to
paint a picture of better financial position. Current ratio can be
calculated as follows:
Current Ratio = Current Assets
Current Liability
For Toptree Company Ltd., Current ratio =
2008 2007
31,870 = 3.7:1 26,620 = 3.5:1
8,640 7,680
From the above computations, it can be deduced that
Toptree’s Current Ratio increased slightly in 2008 over 2007
and both are good.
Quick (Acid Test) Ratio
This measures the ability of a firm to pay all of its current
liabilities if they come due immediately. (Dansby et al., 200:
828). It is a better measure of liquidity because unlike current
ratio, it omits stock or inventory (which may not be easily
19
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.
(Lasher, 1997:70). The standard for quick ratio is 1:1. Quick or
acid Test Ratio can be calculated as follows:
Quick or Acid Test Ratio = Quick Assets
Current Liabilities.
For Toptree company Ltd, Current ratio =
2008 2007
31,870 = 3.7:1 26,620 = 3.5:1
8, 640 7,680
For the above computations, it can be deduced that
Toptree’s Current Ratio increased slightly in 2008 over 2007
and both are good.
QUICK (ACID TEST) RATIO
This measures the ability of a firm to pay all of its current
liabilities if they come due immediately. (Dansby et al.,
2000:828). It is a better measure of liquidity because unlike
current ratio, it omits stock or inventory (which may not be
20
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,
discerning test. (Lasher, 1997:70). The standard for quick ratio
is 1:1 quick or Acid Test Ratio can be calculated as follows:
Quick or Acid Test Ratio = Quick Assets
Current Liabilities
i.e Current Assets - Inventory
Current Liabilities
For Toptree, Quick Ratio =
2008 2007
31,870 – 10,820 26,620 – 9,650
8,640 = 2.4:1 17,680 = 2.2:1
Form the above computations, it is obvious that Toptree
can pay off its current liabilities without selling any inventory.
PROFITABILITY (ACTIVITY) RATIOS
Profitability refers to the ability of a firm to earn a
satisfactory income or return on investment in the business.
Therefore, profitability ratios measure the profit or money
21
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.
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.
22
GROSS PROFIT MARGIN
This is otherwise known as the percentage of Gross profit
to Net sales.
It is a measure of efficiency of the sales of a firm in
relation to the cost of goods sold. It indicates a firm’s ability to
control cost of vice versa.
Gross profit margin can be calculated as follows:
2008 2007
15,787 X 100 = 21.1% 13,536 X 100
72,800 64,700 = 20.9%
NET PROFIT MARGIN
This id otherwise called the percentage of Net profit to Net
sales. It is a measure of the proportion of net sales that
remains after the deduction of all costs and expenses. It
indicates the ability of a firm to control operating and non-
operating expenses.
Net profit margin can be calculated as follows:
Net Profit Margin = Net Income X 100
Net Sales
23
For Toptree Company, Net profit Margin =
2008 2007
9,064 X 100 = 12.5% 7,684 X 100 = 11.9%
72,800 64,700
The above figures indicate that the Net profit Margin is far
below the Gross profit Margin in both years. Nevertheless, the
results were generally favorable.
RETURN ON ASSETS (ROA)
Return On Assets (ROA) measures the overall ability of the
firm to utilize the assets in which it has invested to earn a
profit. (Lasher, 1997:76). It indicates the profitability of a firm’s
assets, the amount of net income it earns in relation to the
assets available for use during the year. (Dansby et al.,
2000:833). The higher the ROA the more profitable is the
assets in producing income. ROA can be divided into two,
namely; return on operating Assets and Return On Total Assts.
However, in general terms and for the purpose of this study,
ROA refers to return on Total Assets.
24
RETURN ON OPERATING ASSETS
This measures the Profitability of a business in carrying
out its primary functions, by indicating the proportion of the
operating assets that become net operating income. Operating
assets are all assets actively used in producing operating
revenues. Therefore, non operating assets such as land held for
future use, a factory building ranted to another company, and
long-term bond investments are excluded when calculating
return on operating assets. (Hermasnon et al. 1992:837) The
formula is:
Return on Operating Assets = Net Operating Income
Average Operating Assets
Or Net Operating Assets
Average Total Assets (Where there are no non-operating
assets)
For Toptree, Return on Operating Assets =
2008 2007
15,787 = 29.3% 13,536 = 28.0%
53, 780 48,380
25
RETURN ON TOTAL ASSETS
Return On Total Assets quantifies the success of the
efforts of a business in using its assets earn profit by stating
net income or profit after tax as a percentage of total assets.
Return On Total Assets = Net Income X 100
Average Total Assets
For Toptree Company, Return On Total Assets or ROA =
2008 2007
9,064 X 100 = 16.9% 7,684 X 100 = 15.9%
53,780 48,380
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
26
On Capitals Employed (ROCE) or Return On Investment (ROI)
because it shows proportion of capital employed, stockholders
equity or owners investment (total assts less total liabilities or
debts) which return to owners or stockholders as net income.
ROE can be calculated as follows
ROE = Net Income X 100
Average Stockholder’s Equity
For Toptree Company, ROE =
2008 2007
9,064 X 100 = 22.0% 7,684 X 100 = 22.2%
41,120 34,600
The above results are good, but 2004 is better.
ASSETS MANAGEMENT (EFFICIENCY) RATIOS
Assets management ratios address the fundamental
efficiency with which a company is run. (Lasher, 1997:71). They
show how efficiently the business is utilizing or managing
assets (current assets and fixed assets) in generating revenue
and cash flow. Thus, they are also called Efficiency Rations.
Asset management Rations include: Inventory Turnover,
Average Days’ Inventory On Hand, Accounts Receivable
27
Turnover, Average Collection period for Accounts Receivable,
Total Assets Turnover, and Fixed Assets Turnover.
INVENTORY TURNOVER
Inventory Turnover measures the number of times in
which the average inventory or stock is sold in a give perio.
This is of prime importance to management because for a
business to generate greater sales volume for the year, it ,must
but, sell and replenish its goods or stock as rapidly as possible.
(Dansby et al, 2000:830).
Inventory Turnover an attempt to measure whether or not
the firm has excess funds tied in inventory. A higher inventory
turnover is better in that it implies doing business with less
fund tied up in inventory. A low inventory turnover figure can
mean some old inventory is on the books that being used.
Holding inventory costs money-it involves the cost of storage,
pupilage, obsolescence, etc.
The ratio is calculated as follows:
Inventory Turnover = Cost of goods sold
Average Inventory
28
For Toptree, Inventory Turnover =
2008 2007
37,500 = 3.7times 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 2007
365 days = 98.6 days 365 days = 107.4 days
3.7 3.4
29
From the above computations, it could be understood that
although there was improvement in 2008, Toptree holds stock
for very long time in both years before they are sold.
Accounts receivable turnover
Accounts receivable turnover is a measure that indicates
how quickly a company is collecting its accounts receivable. It
is the number of times per year that the average amount of
accounts receivable or debtors is a collected (Dansby et al.
2000:829). It measurers the relative size of accounts receivable
balance and effectiveness of credit polices. The higher the
accounts receivable turnover.
Accounts receivable Turnover can be calculated as follows:
Accounts Receivable Turnover = Net Credit Sales
Average Accounts Receivable
Or Net Sales
Accounts Receivable
(where net credit sales and average accounts receivable are
not possible or available.).
30
Therefore, for Toptree, Accounts Receivable Turnover =
2008 2007
72,800 = 5.3 times 46,700 = 5.5 times
13,850 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
31
Accounts Receivable Turnover
For Toptree, ACP =
2008 2007
365 days = 68.9 days 365 days = 66.4 days
5.3 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)
32
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 2007
72,800 = 1.4 times 64,700 =1.3times
53, 780 48,380
Toptree’s assets turnover rates of 1.3 times and 1.4 times
in 2007 and 2008 respectively are not high. This could mean
that the firm is not generating enough sales for the amount of
assets it has available. However, the fact that this is just one
measure should compel the firm to compare it with the figure
shown by similar business in the same industry.
Fixed assets turnover (fat)
Fixed assets Turnover (FAT) measures the capacity of
fixed assets in producing sales. It shows the relationship
between fixed assets and sales. The ratio is appropriate in
industries where significant equipment is required to be
business. (lasher, 1997:73). A Lower FAT or a reducing sales
33
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 2007
72,800 = 3.3 times 64,700 = 3.0 Times
21,910 21,760
from the above computations it can be deduced that
Toptree improved its equipment utilization in generating sales
in 2005.
Debt management (long-tem solvency) ratios
Debt management Ratios measure how the firm uses
other people’s money to its own advantage. The primary
concern is to ensure that the firm does not borrow so much
that becomes overly risky. (Lasher, 1997:73).
Therefore debt management ratios measure the briskness
of a business. They are also known as long-tern solvency,
liquidity or stability ratios because they focus on the long-tern
34
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.
35
(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 2007
2,660 x 100 = 23.5% 13,780 x 100 =28.5%
53,780 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.
36
Equity Ratio can be calculated as follows:
Equity Ratio = Stockholders’ Equity x 100
Total Assets
37
For Top tree, Equity Ratio =
2008 2007
41,120 x 100 = 76.5% 34,600 x 100 = 71.5%
53,780 48,380
Debt-To-Equity Ratio
This ratio is a measure of mix of debt (total liabilities) and
equity within the firm’s total capital. It states the amount of
owners’ equity in relation to a company’s total liabilities, it is
an important measure of risk because a interest charges. This
makes the firm’s profitability fragile in reversionary times.
(Lasher, 1997:74). It is also known as debt-equity ratio. The
higher the ratio, the better the position of the company in the
eyes of its creditors, lenders, investors and shareholders.
Debt-Equity Ratio is calculated as follows:
Debt-to-Equity Ratio= Stockholders’ Equity
Total Liabilities
For Top tree, Debt-to-Equity Ratio =
2008 2007
41,120 = 3.2:1 34,600 = 2.5:1
12,660 13,780
38
Form the above results, it is obvious that Top tree’s debt-
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
39
For Top tree, leverage Ratio =
2008 2007
4,020 = 0.1:1 6,100 = 0.2:1
41,120 34,600
From the above results, it is clear that Top tree is lowly
geared. It has a good and improving gearing ratio.
Fixed Assets To Long-Term Liabilities
This measures the strength of fixed assets of a business to
provide collateral security or cover for the long-term liabilities.
The higher the ratio, the more secure the long-term creditors or
lenders. A ratio of 2:1 or higher provides a margin of safety to
long-term note holders. (Dansby, et al., 200:832). The ratio is
calculated as follows:
Fixed Assets to Long-Term Liabilities = Fixed Assets
Long-Term Liabilities
For Top tree, the ratio is calculated thus:
2008 2007
21,910 = 5.5:1 21,760 = 3.6:1
4,020 6,100
As shown above, it is clear that Top tree has a strong and
improving ratio of fixed assets to long-term liabilities. Thus, it is
40
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 2007
15,787 = 23.2 times 13,536 = 18.5times
680 730
41
From the above computations, it is apparent that Top tree
has a very strong and improving interest coverage ratio and is
therefore, more credit worthy.
Cash Coverage
This is an extension of TIE, but considers the number of
times interest expended can be paid out of the cash flow or
cash earnings (income from operations or EBIT plus
depreciation or non cash expense). It indicates the strength of
the firm to pay interest charges out of the actual cash earnings
of the firm. In other words, cash coverage compares cash
inflows from operations with cash outflows for interest
expense. (Hermanson et al., 1992:842). The ratio can be
calculated as follows:
Cash Coverage= Income from operations +
Depreciation
Interest
Fixed Charge Coverage (FCC)
This is an extension of TIE where lease payments are recognized as fixed financing charges. FCC thus shows the number of times fixed charges can be paid out of income from operations or EBIT. It must be noted that fixed charges are payments that must be made regardless of business conditions.
42
FCC can be calculated as follows:FCC = Income from operations + Lease Payments
Interest + Lease Payments
43
Assuming that in case of top tree, lease payment of N720 thousand and N740 thousand were made by the firm in 2007 and 2008 respectively, the FCC =2008 200715,787 + 740 = 11.6 times 13,536 + 720 = 9.0 times680 + 740 730 + 720INVESTMENT (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.
44
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
Average number of common stock Number of Ordinary Share
outstanding
For Top tree, EPS =
2008 2007
9,064 = N0.44 7,684 = N0.45
20,460 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)
45
Price/Earnings Ratio (P/E) ratio is a measure of investor
confidence in a company or how the stock rates or values a
business. It indicates the future prospects of stock. (Dandby et
al. 200:836). The ratio compares the market price of the stock
to the EPS calculated from the latest income statement. It tells
how much or number of times investors are willing to pay for a
naira of the firm’s earnings. The higher the P/E ratio the better,
because a naira of earnings translates into more shareholder
wealth at higher P/E ratio.
The ratio can be calculated as follows:
P/E = Market Price Per Share of common stock
EPS
For Top tree, P/E =
2008 2007
1.20 = 2.7 times 1,18 = 2.6 times
0.44 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.
46
Earnings Yield
Like P/E ratio, Earnings Yield indicates return on
investment. It is inverse of P/E ratio expressed as a percentage.
It shows EPS in proportion to market price per share. The
higher the earnings yield the better the return on investment
on the stock of a firm. The ratio is calculated as follows:
47
Earnings Yield = EPS x 100
Market price per share
Or 1 x 100
P/E
For Top tree, earnings Yield =
2008 2007
0.44 x 100 = 36.7% 0.45 x 100 = 38.1%
1.20 1.18
Dividend Per Share (DPS)
Like EPS, Dividend Per Share (DPS) measures the amount
of dividends paid per ordinary share outstanding. It shows the
amount of returns earned by investors in terms of dividend in
relation to their investment in each unit of common stock. The
higher the DPS the better the returns on stockholders’
investment as well as the share holds’ wealth. DPS can be
calculated as follows:
DPS = Dividend
Number of common stock outstanding
48
For Top tree, DPS =
2008 2007
2,650 = N0.13 2,500 = N0.15
20,460 16,900
The above results show that Top tree’s DPS is diminishing.
Dividend payout Ratio (DPR)
Dividend Payout Ratio (DPR)
DIVIDENE PAYOUT ratio (DPR) reveals the dividend
payment and retention policy of the firm. It measures the
percentage of a firm’s distributable earnings that paid out to
ordinary shareholders as dividends. The balance or retained
earnings is reserved as part of shareholders’ fund to meet
future financial needs. It is the percentage of DPS to EPS. The
ratio is calculated as follows:
DPR = DPS X 100
EPS
For Top tree, DPR =
2008 2007
0.13 x 100 = 29.5% 0.15 x 100 = 33.3%
0.44 % 0.45%
49
Dividend Yield
Dividend yield is an investment profitability measure that
tells the investor the rate earned on an investment in common
stock. It is a measure of current return to an investor in
common stock. Dividend Yield is of particular interest to the
investor who is comparing choices of investment and wants to
know the rate that can be earned. (Dansby et al., 2000:837). It
can be calculated as follows:
Dividend yield DPS X 100
Market price per share
For Top tree, Dividend Yield =
2008 2007
0.13 x 100 = 10.8 % 0.15 x 100 = 12.7%
1.20 1.18
Dividend Coverage
Dividend coverage measures the number of times the
earnings of a firm can pay or cover dividend. It indicates the
extent to which earnings will drop before a company may be
unable to maintain the current dividend payout levels. The
higher the ratio the better.
The Formular for Dividend Coverage is:
50
Dividend Coverage=
Net Income or Profit after tax &preferred Dividend
Dividend Dividend on Ordinary Shares
For top tree, Dividend coverage =
2008 2007
9,064 = 3.4 times 7,684 = 3.1 times
2,650 2,500
Market To Book Value Ratio
This compares the market price per share of a company to
the book value per share. It is a broad indicator of what the
market thinks of a particular stock or how the investors value
the stock. A healthy company is usually expected to have a
market value of its shares in excess of the book value. A
market to book value below 1.0 indicates grave concern about
the company’s future. Such a firm is said to be selling “below
book”. (Lasher, 1997:78).
It must be noted that Book Value Per Share is total value
of equity divided by number of common stock outstanding.
Market to Book Value Ratio is calculated as follows:
51
Market to Book Value Ratio = Market Price Per Share
Book Value Per Share
Or market price per share
Equity
(Number of shares outstanding)
For Top tree, Market to Book Value Ratio =
2008 2007
1.20 = 0.6 1.18 = 0.3
(41.120) (34,600)
(20,460) (16,900)
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
52
Pont Corporation are called Du pont Equations (DPEs). (Lasher,
1997:80).
Du pont Equations (DPEs)
These give insight into overall effect of assets
management and debts management on the profitability of the
business. They focus on the relationship between Return On
Assets (ROA), return on Sales (ROS), Total Assets Turnover
(TAT), Equity Ratio and return on Equity (ROE). They indicate
how the performance of a firm in these ratios reflect on the
earning ability and the managerial efficiency of a firm.
In fact, DPEs draw insight into areas or aspects of the
business-ROS (profitability) to be TAT (efficiency) to be
regarded as responsible for any return (ROA or ROE) made
from the business. For instance DPEs may help us see how a
firm whose ROS is above industry average may be forced to
produce a ROA which is below industry average, due to low TAT
(which is below industry average).
The first Du pont Equation is developed by writing the
definition of ROA and multiplying by sakes/sales ( = 1, so that
the multiplication does not change the value of expression).
The equation is stated a follows:
53
ROA = Net Income x Sales
Total Assets Sales
Reversing the order of the denominator:
ROA = Net Income x Sales
Sales Total Assets
That is, ROA = ROS X TAT
This shows that ROA is a product of ROS and TAT. Well, it
must be recalled that ROA is a fundamental measure of
performance indicating how well a company uses its assets to
generate profits. ROS measures how well a firm keeps some of
its sales naira in profit. And TAT measures the company’s
ability to generate sales with the assets it has.
Therefore, the above Du pont Equation tells us that to run
a business well as measured by ROA, we have to manage costs
and expenses well and generate a lot of sates per naira of
assets. (Lasher, 1997:80).
For Top tree, the ROA (using the above Du pont Equation)
=
2008 2007
9,064x72,80 x 100 = 16.9% 7,684 x 64,700 x 100 = 15.9%
72,800 53,780 64,700 48,380
54
The second but extended Du pont Equation is developed
by writing the definition of ROE and multiplying sales/sales and
by total assets/total assets. The equation is stated as follows:
ROE = Net Income x Sales x Total Assets
Equity Sales Total Assets
Re-arranging the denominators:
ROE = Net income x Sales x Total Assets
Sales Sales Equity
That is, ROE =ROA x Equity Multiplier.
Then, ROE = 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
55
words, the way you finance a business can greatly exaggerate
the results of “nuts and bolts” operations. (Lasher, 1997:81).
For Top tree, ROE (using the Extended Du pont Equation)
=
2008 2007
9,064x 72,800 x 53,780 x 100 7,684x64,700x48,380x
100
72,800 53,780 41,120 64,700 48,380 34,600
= 22.0% = 22.2%
Application of DPEs
Comparing Du pont Equatiions between a company and
an industry average can give some insights into how a firm is
doing in relation to its competitors. For example, we have the
following data for Top tree Company and its industry.
ROA = ROS X TAT
Top tree Company 16.9% 12.5% 1.35 X
Industry Average 19.3% 5.5% 3.5 X
If Top tree is trying to figure out why its ROA is below
average, this display focuses attention in the right direction.
56
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
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:
57
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
development coat, and such may result to differences in the
net income of essentially identical firms.
2. Inflation:Financial statements do not reveal the impact of
inflation on the reporting entity. (Hermanson et al), (1992:848).
Real estate purchased years ago for example, will be carried on
the Balance sheet at its original cost. Yet it may be worth many
times the amount in today’s market. During periods of rapid
inflation, inventory, cost of sales and depreciation can badly
distort true results. (Lasher, 1997:82,83).
3. Window Dressing: In a deliberate attempt to make
Balance sheets look better than they otherwise would, firms try
to make some year-end improvements that don’t last, in their
finances. For instance, a company with a low current ratio may
try to improve it by borrowing a long-term loam a few days
before the end of the year, holding the proceeds in cash over
year-end, and repaying the loan a few days later.
58
4. Historical Information: financial ratios are computed
from historical accounts, and historical information is of little
use in assessing future prospects of a company. This is
because trends do reverse and past may not be a useful
measure of adequacy. Thus, past performance may not be
enough to meet present needs and make reliable projections.
5. Uniqueness Of Companies: Every Company is unique in
size, operation, management, and location. Thus, two
companies that operate in the same industry may not be
strictly comparable. For instance, comparing a firm which
finances its fixed plant through rental, (thus not showing it as
an asset), with a firm which purchases its own assets will be
difficult irrespective of their operation in the same industry or
sector. (Omuya, 1983:456).
6. Limited Information: Financial statements do not
present information that covers all aspects of the business.
Therefore, financial ratios provide only quantifiable or
quantitative information and omits non-quantifiable or
qualitative information such as managerial skills, staffing
requirement, and changes in the operating environment, which
59
are all necessary variables determining the success of a
business.
7. No Universal Standard: Financial ratios do not have
universally accepted standards, norms or yardsticks for
comparison. Standards are used in accordance with industry,
firm, circumstance and objective pursued. For instance, the
rule-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
60
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
3.1 INTRODUCTION
This chapter describes the methods and procedures used in
geothermic data that was analyzed in chapter four, necessary
to accomplish the purpose of this study. The research
methodology is vital part of the research report because
according to Osuala (1987:32), it is the background against
which the reader evaluates the findings and the contusions.
3.2 RESEARCH DESIGN
This study is a surrey designed to find out the role of ratio
analysis in business decisions; it is descriptive and analytical in
nature.
3.3 DATA COLLECTION TECHNIQUE
The two main sources of data collection used in the study
are the primary and the secondary sources.
* PRIMARY SOURCES
Primary sources of data collection are first hand
information i.e. information that was gathered by the
researcher himself directly from the respondents. In this
regains, questionnaire and oral interviews were used to collect
63
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
management staff.
64
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 (a constant)
(e) 2 = level of significance ((e) = 0.05)
n = 27
1 + 27 (0.05) 2
n = 27
1 + 27 (0.025)
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
questionnaires to the respondents.
66
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.
67
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.
68
TABLE 4.1 QUESTIONNAIRE DISTRIBUTIONS AND COLLECTION
Staff position Administered Returned Not returned
Mgt, Staff 5 20% 5 20% 0 0%
Non-Mgt. staff 20
80%
15 60% 5 20%
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.
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4.2.1 QUESTION NO 5
What is the highest education qualification level obtained?
TABLE 4.2 HIGHEST EDUCATION QUALIFICATION LEVEL
OBTAINED
Level Mgt. Staff Non mgt. staff Total
Msc 1 5% - 0% 1 5%
Bsc 2 10% - 0% 2 10%
Hnd 2 10% 6 30% 8 40%
Ond 0 0 % 7 35% 7 53%
O level 0 0 % 2 10% 2 10%
Total 5 25% 15
75%
20 00%
SOURCE: QUESTIONNAIRE
From the table 4.2 above showing the highest
qualification education obtained by all the staff, shows that 1
(5%) out of 5 (25%) is an Msc holders, 2 (10%) out of 5 (25%)
of the management staff are Bsc holders, 2(10%) out of 5
(25%) of the management staff are HND holders. Coming to the
Non management staff 6 (30%) out of 15 (75%) are HND
holders, 7 (35%) out of 15 (75%) are OND holders, while 2
(10%) of the remaining are O level holders.
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4.2.2 QUESTION NO 6
Do you agree that Ratio Analysis facilitates proper
understanding of information contained in financial
statements?
TABLE 4.2 RETIO ANALYSES AS A FACILITOR OF PROPER UNDESTANDING OF
FINANCIAL STATEMENTS
Responses Mgt. Staff Non-mgt.
staff
Total
Yes 5 20% 15 75% 20 100%
No 0 0% 0 0% 0 0%
Total 5 20% 15 75% 20 100%
SOURCE: QUESTRIONNAIRE
As shown in the table above all the 20 (100%) of
respondents agreed that Ratio Analysis facilitates proper
understanding of information contained in financial statements.
4.2.3 QUESTION NO 7
Do you think that Ration Analysis is useful to
management, investors, shareholders and creditors in their
business decisions?
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TABLE 4.4 USEFULNESS OF RATIO ANALYSIS IN BUSINESS
DECISIONS.
Responses Mgt. staff Non mgt.
staff
Total
Yes 5 25% 13 65% 18 90%
No 0 0% 2 10% 2 10%
Total 5 25% 15 75% 20 100%
SOURCE: QUESTIONNAIRE
The table above shows that i8 out of 20 or (90%) out
(100%) of the respondents agreed that Ratio Analysis is useful
to management, investors, shareholders, and crediting in their
business decisions.
4.2.4 QUESTION NO 8
Do you believe that efficient use of financial ratios helps is
evaluating and predicting the performance and financial
position of a business, as well as identifying areas that require
improvement?
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TABLE 4.5 USE OF FINANCIAL RATIOS IN EVALUATION AND
PREDICTION OF BUSINESS PERFORMANCE
Responses Mgt. staff Non mgt.
staff
Total
Yes 5 25% 12 60% 17 85%
No 0 0% 3 15% 3 15%
Total 5 25% 15 75% 20 100%
SOURCE: QUESTIONNAIRE
Table 4.4 shows that 17(85%) out of 20 (100%) of the
respondents agreed that efficient use of financial ratios helps in
evaluating and predicting the performance and financial
position of a business.
4.2.5 QUESTION NO 9
Do you agree with the saying that ratio Analysis helps us
to ask the right questions but do not provide answers unless
the right comparative standards and techniques are used.
TABLE 4.5 RATION ANALYSIS PROVIDE THE RIGHT ANSWER
WHEN RIGHT COMPARATIVE STANDARDS AND TECHNIQUES
Response Mgt. staff Non-mgt.staff Total
Yes 5 25% 10 50% 15 75%
No 0 0 % 5 25% 5 25%
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Total 5 25% 15 75% 20 100%
SOURCE: QUESTIONNAIRE
From the table 4.5 above it shows that 5 (25%) the mgt,
staff agreed with the fact that Ratio Analysis answers the right
Question when the right comparative and technique are used,
10 (50%) of the non mgt, staff also agree. While 5 (25%) of
non-mgt, staff did not agreed with that saying.
4.2.6 QUESTION NO 10
Are there obstacles to the proper use of financial ratios in
business decisions?
TABLE 4.7 OBSTACLES TO THE USE OF FINANCIAL RATIOS
Responses Mgt, staff Non-mgt,
staff
Total
Yes 5 25% 14 70% 19 95%
No 0 0% 1 5% 1 5%
Total 5 25% 15 75% 20 100%
SOURCE: QUESTIONNAIRE
From the table above, it can be deduced that 19 (95%)
out of the 20 respondents agreed that there are obstacles to
the proper use of financial ration in business decisions.
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QUESTION NO 10b (ANSWER)
Obstacles to the use of financial ratios:
* A financial ratio deals only with numerical items and does
not look at
* In periods of inflation, the ratios comparing sales and net
income to non-numerical factors like management’s
ethical relies. assure and equity may be biased upwards.
* Ratios show relationship as they exist in the past at a
particular balance sheet date. Therefore analyst
interested in the future should be mislead into believing
that the past data necessary reflects the current or future
situation.
Obstacles such as economic, socio culture,
political, climatic and competitive conditions existing in
the external environment of a business which are beyond
the control of the business but has direct influence on its
performance.
4.2.7 QUESTION NO 11
75
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 Non-mgt staff Total
Yes 5 25% 14 70% 19 95%
NO 0 0% 1 5% 1 5%
Total 5 25% 15 75% 20 100%
SOURCE: QUESTIONNAIRE
From the table 4.6 above it show’s that all the mgt, staff
agreed that financial ratio help to unravel the mass truth
hidden in the financial statement while 14 (70%) of the Non
mgt staff also agreed bringing a total of 19 (95%) of the
respondent disagree with that fact.
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CHAPTER FIVE
SUMMARY, CONCLUSION AND RECOMMENDATIONS
5.1 INTRODUCTION
This chapter concludes the project. It contains the
summary of the research findings, the conclusion, and the
recommendations offered by the researcher based on the
findings.
5.2 SUMMARY AND DISCUSSION OF FINDINGS
With particular reference to the organization under study
as well as the literature review, the research are summarize
and discussed as follows:
1. Ration analysis facilitates proper understanding of
information continued in financial statements and aids business
decisions. According to Essien (2006:11), “financial statements
carry lots of financial statements become more useful when
they are related each other or to some other relevant financial
data by means of rations.”
2. Financial rations are useful in evaluating and predicting
the performance and financial position of a business, as well as
identifying areas that need improvement. Norbert f. Lindsborg
of Harold Washington college (in Dansby et al, 2000: 181)
78
observed: “ As an investor in a corporation or as owner or
manger of a business, you are naturally interested in knowing
how well the firm is doing financially. You will want to compare
this year’s is available to pay bills in the near future.
3. despite the obstacles to the proper use of financial ratios,
there are helpful suggestions on ways to enhance efficient use
of ratio analysis in decision-making. According to Lasher
(1997:69,82); “although ratio analysis is a powerful tool, it has
some significant shortcomings. Analysis have to be careful not
to apply the techniques blindly to any set of statements they
come across, due to differences in business and accounting
methods.
Hermason et al. (1992:846), “financial analysis relies
heavily on informed judgment. Percentages and rations are
guides to aid comparison and useful in uncovering potential
strengths and weaknesses. However, the financial analysis
should seek the basic causes behind and established trends”.
4. Financial rations need to be carefully computers and used
with the right yardsticks of comparison in order to of optimal
benefit to the users. In this regard, Omuya (1983:456),
“Interpretation of a change in a ratio needs careful examination
79
of changes in both numerator and denominator. Without very
full and detailed investigation some wrong conclusion can as
drawn.”
5.3 RECOMMENDATIONS
With reference to the findings of the study, the researcher
recommends the following:
1. Users of financial statements need to have at least, a fair
knowledge of accounting so as to enable then understand and
appreciate accounting information.
2. Prospective investors should properly analyze the financial
statements of companies before deciding to invest in the
companies.
3. Users of financial statement who are not knowledgeable
enough to analyze or understand the information contained in
them should seek the services of qualified financial analysts,
accountants, stockbrokers, bankers, etc.
4. In view of the remarkable influence which accounting
informations have on the decisions of the users, it is pertinent
that only qualified and honest persons should and audit
financial statements.
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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
decision.
6. financial ratios should be judiciously used by firms,
investors, lenders, shareholders, managers, and other
stakeholders, in view of their numerous benefits and
limitations.
5.4 CONCLUSION
Financial statements contain lots of information
summarized in figures. Viewed on the surface, they do not
provide enough information about the viability of the reporting
entity. Thus, they need to be analyzed by means of financial
ratios to unravel the mass of truth hidden in them, and to
enhance decision-making.
Ratio analysis helps to reveal, compare and interpret
salient features of financial statements. When applied to a set
of financial statements, financial ratios highlight significant
aspects of the financial position and operational results of a
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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
business, and paves way to finding the useful answers. Such
analysis therefore, aids planning, control, forecasting and
decision- making.
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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:
(a) male [ ] (b) female [ ].
2. Which position do you occupy on the organization?
(a) Management staff [ ] (b) Non management staff [ ]
3. Do you believe that financial statements- income
statement and balance sheet are effective ways of
communicating financial information?
84
(a) Yes [ ] (b) No [ ].
4. Is Ratio Analysis used by your firm as a decision making
tool?
(a) Yes [ ] (b) No [ ].
5.What is the highest level of education that you obtained?
(a) Msc [ ] (b) Bsc [ ] (c) HND [ ]
(d) OND [ ] (e) O Level [ ].
6. Do you agree that ratio analysis facilitates proper
understanding of information contained in financial
statements?
(a) Yes [ ] (b) No [ ].
7. Do you think that Ratio Analysis is useful to management,
investing shareholders and creditors in their business
decisions?
{a} Yes [ ] (b) No [ ].
8. Do you think that financial ratios are useful in evaluating
and predating the performance of a business as well as
certifying areas that require improvement?
{a} Yes [ ] (b) No [ ].
85
9. Do you agree with the saying that rotor analysis helps its
to ask the right questions but do not provide answers unless
the right comparative standards and techniques are used?
{a} Yes [ ] (b) No [ ].
10. Are there obstacles to the proper use of rotor analysis in
your business clerisies?
{a} Yes [ ] (b) No [ ].
10b If (10) above is “yes”, then state the obstacles?
11. Does financial retro helps to unravel the mass of truth hidden in financial statement?{a} Yes [ ] (b) No [ ].
86
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