Abstract

Accounting information provided by means of financial statements- The income statement and the Balance Sheet are often in summarized form. Viewed on the surface, the truths about the results and the financial position of a business hidden in them remain veiled.

To be of optimal benefit and as well enable the users make well – informed decisions, financial statements need to be analyzed by means of ratios. Therefore, in order to establish the role of ratio analysis in business decisions both the financial accounting and management will be considered.

CHAPTER ONE

INTRODUCTION

1.1. Background To The Study

The two primary objectives of every business are profitability and solvency.  Profitability is the ability of a business to make profit, while solvency is the ability of a business to pay debts as they come due.  (Hermanson et al, 1992: 824). The achievement of these objectives requires efficient management of resources of the business through planning, budgeting, forecasting, control, and decision–making.  Also, the strengths and weakness of the business need to be identified and necessary corrective measures applied.  Interestingly, accounting provides information that facilitates these functions.

Basically, accounting measures and communicates economic information needed for decision–making.  Thus, the American Accounting Association in Okezie (2002:1) defined accounting as “the process of identifying, measuring and communicating economic information to permit informed judgments and decisions from the Income Statement and the Balance Sheet”.  The Income Statement shows the profitability or operational result of a business, while the Balance Sheet shows the solvency or financial position of a business.

Although profits are often used as the basis for judging the performance of a business, such profits must be related to the various items of the financial statements in order to be meaningful and useful for decision making. Furthermore, owing to the summarized nature of financial statements, a lot of truth is hidden in them. Thus, they need to be analyzed and interpreted by means of financial ratios to enable the users understand the meaning of the absolute amounts shown in them, and make informed business decisions.

Business decisions like to make or buy, investment or divestment, expansion or contraction, capital-organization or reconstruction amongst others cannot be properly made without the aid of financial ratios. They give cue to the financial strengths and weaknesses of a business, and highlight aspects of a business requiring further investigation. In this research I will focus on the Profitability ratio, Liquidity ratio, Leverage ratio and activity ratio.

The Accounting Standards Board recommends that listed companies include an operating and financial review that provides ‘a framework for the directors to discuss and analyses the business’s performance and the factors underlying its results and financial position, in order to assist users to assess for themselves the future potential of the business’ (Blake, 1997). The following accounting information found on the Profit and Loss account, Balance Sheet and Cash Flow statement can be studied using ratios.

Ratios are typically two numbers, with one being expressed as a percentage of the other. Ratio analysis can be used to help interpret yearly trends in performance and by benchmarking to industry averages or to the performance of individual competitors. Ratio analysis can be used to interpret performance against five criteria: the rate of profitability; liquidity, i.e. cash flow; gearing, i.e. the proportion of borrowings to shareholders’ investment; how efficiently assets are utilized; and the returns to shareholders.

This research is therefore carried out to show how ratio analysis helps managers, shareholders, investors, creditors, and other stakeholders make informed judgments and decisions about the past performance, present condition, and futures potential of a business.

1.2. Statement Of Problem

Financial ratio analysis is important to the management, owners, personnel, customers, suppliers, competitors, regulatory agencies, tax payers and lenders each having their views in applying financial statement analysis in their evaluations and making judgments about the financial health of organization. Many organizations also compare their own ratio values to those for similar organizations looking for differences that could indicate weaknesses or opportunities for improvement (Vincent, 2013).

Financial statements carry lots of financial Information that are hidden and summarized in figures. The figures in financial statements become more useful when they are related to each other or to some other relevant financial data. Furthermore, owing to the summarized nature of financial statements, a lot of truths are hidden in them. Thus, they need to the analyzed and interpreted by means of financial ratios to enable the users to understand the meaning of the absolute amounts shown in them, and make informed business decisions.

Managers want information because they need to make decisions. The proper use of information is an important part of decision-making. Remarkably, one of the effective ways of providing the information needed for decision-making is ratio analysis. Therefore, this research paper is carried out to show how ratio analysis helps the management of Global Business Strategy Limited Limbe make informed judgments and decisions about the past performance, present condition, and future potential of a business.

1.3. Research Questions

1. Is ratio analysis useful in evaluating and predicting the performance of a business as well as intensifying areas that need improvement?
2. Is ratio analysis useful to management investors, shareholders and creditors in their business divisions?
3. Does financial ratio help to unravel the mass of truth hidden in financial statements?

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