CHAPTER ONE
1.1 Background to The Study
The financial statement of the firm
at the end of the annual year provides a more significant tool of analyzing
information to facilitate in making useful business and investment decision.
This can be achieved through the use of accounting ratio analysis. Accounting
ratios facilitates the determination of the efficiency and profitability of a
firm which is fundamental for investment decisions based on the firm’s
financial reports. Accounting ratio facilitate the comparison of two aspects of
a financial statement. Some example of accounting ratios include the dividend ratio, gross
margin ratio, debt-to-equity ratio, and operating margin ratio. The relevance
of this ratio for investment decisions depends on the currency of the data in
the financial statement. The statement used for accounting ratio analysis is the
annual financial report of a firm which consists of three financial statements: the balance
sheet, income statement and cash flow statement. The analysis conducted in each
of this statement provides the vital information required regarding the financial
performance of the firm for making sound investment decisions. Analysts
therefor depend on the use of the
financial statements to provide the data needed to update accounting ratios.
According to Igben (1999:423), “Accounting {or financial} ratio consist of the
fraction, proportion or percentage which compare the relationship between one
variable item in a set financial statements with another item in the financial
statements. Consequently, Accounting ratios are vital for the analysis and
interpretation of financial statements”.
The research therefore seeks to investigate the role of accounting ratio
analysis in measuring financial performance of a firm and aiding investment
2Gross
Margin and Operating Margin
3The income statement contains information
about company sales, expenses and net income. It also provides an overview of
earnings per share and the number of shares outstanding used to calculate it.
These are some of the most popular data points for analysts to use when
computing accounting ratios dealing with profitability. For example, gross
profit as a percent of sales is an accounting ratio referred to as gross
margin. It is calculated by dividing gross profit by sales. For example, if
gross profit is $80,000 and sales are $100,000, the gross profit margin is 80%.
Operating profit as a percentage of sales is referred to as operating profit
margin. It is calculated by dividing operating profit by sales. For example, if
operating profit is $60,000 and sales are $100,000, the operating profit margin
is 60%. Both accounting ratios provide information about company profitability.
4Debt-to-Equity
Ratio
5The balance sheet is a snapshot in
time and provides accountants with data for calculating credit and debt ratios.
The most popular debt ratio is debt-to-equity. It is calculated by dividing
debt by equity. For example, if a company has debt equal to $100,000 and equity
equal to $50,000, the debt-to-equity ratio is 2 to 1.
6Payout
Ratio
7The cash flow statement provides
data for ratios dealing with cash. For example, the payout ratio is the
percentage of net income paid out to investors. Both dividends and share
repurchases are considered outlays of cash and can be found on the cash flow
statement. For example, if dividends are $100,000, share repurchases are
$100,000, and income is $400,000, the payout ratio is calculated by dividing
$200,000 by $400,000, which is 50%.
1.2 Statement of the Problem
The need to determine the financial performance of the firm
is crucial for making informed decisions concerning the further deployment of
resources and investment decisions. This can only be done through accounting
ratio analysis. Eventually this is not often an easy task to undertake as many
investors and business owners lack the understanding and skill to perform
accounting ratio analysis. Accounting ratios facilitates the determination of
the efficiency and profitability of a firm which is fundamental for investment
decisions based on the firm’s financial reports. Accounting ratio facilitate
the comparison of two aspects of a financial statement. Some example of
accounting ratios include the dividend
ratio, gross margin ratio, debt-to-equity ratio, and operating margin ratio.
The relevance of this ratio for investment decisions depends on the currency of
the data in the financial statement. The statement used for accounting ratio
analysis is the annual financial report of a firm which consists of three financial statements: the balance
sheet, income statement and cash flow statement. The analysis conducted in each
of this statement provides the vital information required regarding the
financial performance of the firm for making sound investment decisions.
Analysts therefor depend on the use of
the financial statements to provide the data needed to update accounting
ratios. According to Igben (1999:423), “Accounting {or financial} ratio consist
of the fraction, proportion or percentage which compare the relationship
between one variable item in a set financial statements with another item in
the financial statements. Consequently, Accounting ratios are vital for the
analysis and interpretation of financial statements”.
Therefore, the problem confronting the research is the role of accounting ratio
analysis in measuring financial performance of a firm and aiding investment
1.3 Objectives of the Study
1.
To
determine the role of accounting ratio analysis in measuring financial
performance of a firm and aiding investment.
2.
To examine the relevance of accounting
ratio analysis in the determination of financial performance of a firm and
investment decision.
1.4 Research Questions
1.
What
is the role of accounting ratio analysis?
2.
What
is the relevance of accounting ratio analysis in the determination of financial
performance of a firm and investment decision?
1.5 Significance of the Study
The research shall proffer a structural appraisal of
accounting ratio analysis for the determination of the firm’s financial
performance and investment decision.
1.6 Research Hypothesis
Ho The role of accounting ratio analysis in measuring
financial performance of a firm and investment decision is not significant
Hi The role of accounting ratio analysis in measuring
financial performance of a firm and investment decision is significant
1.7 Scope of the Study
The study focuses on the appraisal of the role of accounting
ratio analysis in measuring financial performance of a firm and aiding
investment
1.8 Limitations of the Study
The study was faced with some constraint such as logistics
and and geographical factor.
1.9 Definition of Terms
Accounting: Accounting is the
recording, summarizing, analysis and interpreting financial information which
facilitate informed judgments and decisions. (Dansby et al., 2000: 1033).
Balance
Sheet:
A financial statement shows the financial position of the firm at a particular
period of time. It reflects information regarding the assets, liabilities, and
owner’s equity or capital (Akpakpan, 2002:106).
Business:
An institution which is formed for conducting business actiivies of providing
goods and services for the purpose of making profit. And satisfying human needs
Financial Ratio: “Accounting {or financial} ratio
consist of the fraction, proportion or percentage which compare the
relationship between one variable item in a set financial statements with
another item in the financial statements.
REFERENCE
Akpakpan, Bassey A. (2000). Accounting for Beginners: An Introduction to
Financial Accounting. Part 1. (2005). Guideline on Project Writing: Introducing
Students to Research through Practical Approach. Revised ed. Uyo: Abaam
Publishing Co.
Ayandele, I. A. (2005) Quantitative Techniques for Managerial Decision. Uyo:
Cle-Print Publishers.
Bittel, Lester R., Ronald S. Burke & Lawrence R. Lafarge. (1984). An
Introduction to Business in Action. 2nd ed. New York: McGraw Hill Book Company.
Dansby, Robert L., Burton S. Kaliski
& Michael D. Lawrence. (2000). Paradigm College Accounting. 4th ed. St
Paul, MN: Paradigm Publishing Inc.
Essien, enefiok E. (2006)
Entrepreneurship: Concept and Practice. Uyo: Abaam Publishing Co.
Hermanson, Roger H., James Don Edward & Michael W. Maher. (1992).
Accounting Principles. 5th ed. Boston, MA: Richard D. Irwin, Inc.
Hornby, A. S., et al.. (2000). Oxford
Advanced Learner’s Dictionary. 6th ed. Oxford: Oxford University
Press.
Igben, Robert O. (1999). Financial
Accounting Made Simple. Lagos ROI Publishers.
Ikon, Micheal A. (2004). An
Introduction to Business in the Nigeria Environment. Onitsha: Ngotel Publishers.
Inanga, Eno L. (1999). Principles of
Accounting 2nd ed. Ibadan: Heinemann Educational Books Plc.
Lasher, William R. (1997). Practical Financial Management. St Paul, MN. West
Publishing Company.
McShane, Steven L.& MaryAnn Von Glinow (2000). Organizational Behavior.
Boston: Irwin McGraw Hill.
Nwachukwu, Vitalis O. & Kelechi G.Egbulonu. (2000). Elements of Statistical
Inference. Owerri: Peace Enterprises Ltd.
Okezie, B. N. (2002). Fundamentals of Financial Accounting. Owerri: BON
Publications.
Omuya J. O. (1983). Frank Wood’s Business Accounting. West Africa
ed. Volumes 1&2. London: Longman Group
Ltd.