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USES OF
ACCOUNTING RATIOS IN BUSINESS DECISIONS
ABSTRACT
Accounting
ratio is the most important factor used by management, creditors, investors and
other users of financial statement in carrying out most business
decisions. It uses an application in
making most business decisions remain inevitable.This study has, therefore been
divided into five chapters; the first chapter briefly introduced the topic by
looking at the definition of accounting ratio; it contains the statement of
problems, the objective of the study and the limitation of the study.The second
chapter, which contains the profile of Nigerian Breweries PLC deals with the
review of related literature on the topic.Chapter three deals with the method
of carrying out the research methodology.Chapter four appraises the analysis
and interpretation of data collected from respondents.Finally, chapter five
included the summary, recommendations and conclusion. Any errors either by
omission or commission are entirely unintentional and deeply regretted.
CHAPTER ONE
INTRODUCTION
1.1 BACKGROUND OF THE STUDY
Omuya (1990)
defined “Accounting as a language of business, it is used in the business world
to describe the transaction entered into by all kinds of organization. An
analysis of the above definition shows that Accounting centres on transforming
data into information that would be useful to many users. It takes care of the financial communication
of the entry as it supplies the financial information in a way and, form so
desired by the users.
In a similar
case Millichamp (1992) defined Accounting as “the art of recording, classifying
and summarizing in a significant manner and in terms of money, transactions and
events which are in part at least of financial statement”. These users include owners, (shareholders)
managers, suppliers, customers, government employees, etc. The users of these statements are expected to
read, interpret and analyze them.
Objectives of financial statements are not accomplished when many users
of the statement cannot understand them, let alone interpret and analyze them.
The
information the users attempt to gain from financial statement are:
(i) The ability of the
business to pay its way and survive in the long run.
(ii) The quality of
management and the rightness of decision made.
(iii) Information that guide
the future.
Regrettably,
the inability of users of these financial statements to comprehend, interpret
and analyze the and still has always contributed to harmful business and
investment decision by the users of these statements. As a result of these wrong business
decisions, many users of these statements have been rendered poor, whereas
others are afraid and show indifference to investment and business opportunities. Cases abound where these financial statements
users, individual and corporate, have lost millions of Naira merely because of
wrong business decisions.
Admittedly,
faulty business decisions do not only affect management and investors, it also
affects the entire economic growth and development.
Indeed,
these problems of wrong investments and business decisions therefore prompted
this research work and topic. Reason
behind the topic is the discovery that many victims of wrong business decisions
are people and firms who do use analytical tool otherwise known as Ration
Analysis in their decision making process.
“Ratios are
simply mathematical expression of relationship of one figure to another which
may come from the same statement or from different statement (Atman Edward
1968). Accounting ratios, by their very
nature serve as indicator of the performance of a company both past and
present.
According to
Millichamp (1992) “Ratio Analysis is used to assess performance and liquidity
and to forecast the future by extra piloting trend” thus ratio analysis is
analytical technique used in making business decisions in the centre of this
research work.
1.2 STATEMENT OF THE PROBLEMS
Currently,
many users of financial statements are not yet equipped, analytically to make
good business decisions, notwithstanding companies and workshops on the benefit
of accounting ratios. Efforts have been
made to enlighten and educate financial statement users that their future
business predictions are based on accounting ratios, which use historical data.
However,
these efforts have not made any meaningful charge because the number of wrong
decision makers is on the increase. Some times this attributed to total
disregard of ratio analysis by financial statements users. Perhaps, ratio analysis itself confuses them
more and increases their tendency of becoming victims of inadequate business
decisions.
Against this
background, these situations become puzzling and have constituted research
problems.
1.3 OBJECTIVE OF THE STUDY
The
objective of this research is to assist in identifying and disclosing the
extent to which accounting ratios help in decision making in business.
The writer
has in mind that the research will help to strengthen the weakness faced by the
companies in their business decisions and at the same time find solutions to
the following problems.
(1) How accounting
ratios confuse financial statement users and increase their tendency of
becoming victims of inadequate business decisions.
(2) The ignorance of
importance of accounting ratio is responsible for detective business decisions
by users of financial statements.
(3) The negligence and
disregard of ratio analysis responsible for wrong business decision by users of
financial statement.
1.4 RESEARCH QUESTIONS
The
questions this research work is seeking the answers are as follows:
(a) Do accounting
ratio confuse financial statement users and increase their tendency of becoming
victims of inadequate business decisions?
(b) Is ignorance of
importance of accounting ratio responsible for defective business decisions by
users of financial statements?
(c) Are negligence and
disregard of ratio analysis responsible for wrong business decisions by users
of financial statement?
(d) Do financial
statements contain differences and trouble that misdirect their users?
(e) Do users of
these statements require more enlightenment campaigns and workshops to enable
them comprehend their importance?
(f) To what extent
do accounting ratios used for financial analysis and a tool for business
decisions?
1.5 SIGNIFICANCE OF THE STUDY
Many
scholars have written about the importance of financial analysis to business
world. Others have also written on ratio analysis as a test to firms’ solvency.
However, no
attempt has been made that wrong or inadequate business decision-making
process. This, of course, is where this
research work is different from these other writings.
Additionally,
ratio enables prospective leaders to decide whether to provide assistance to a
evaluate results and to use them as a guide in controlling their firms. With the help of accounting ratios, creditors
are well positioned to know whether their firms are able to pay their debts as
they fall due. Stockholders know the performance of their firm, while investors
are able equipped to predict the financial future of a particular firm before
going into investment. The study also
serves as a source of data for future research on this topic and related topic.
1.6 FORMULATION OF HYPOTHESIS
The
researcher wishes to test eight hypotheses in this research work.
HYPOTHESIS 1
H0: Accounting ratio is not useful in making
business decisions.
H1: Accounting ratio is useful in making
business decisions.
HYPOTHESIS 2
H0: Accounting ratio does not accelerate
business decision-making process.
H1: Accounting ratio accelerates business
decision-making process.
HYPOTHESIS 3
H0: Management does not appraise their
efficiency and effectiveness in using resources with the aid of accounting
ratios.
H1: Management does appraise efficiency and
effectiveness in using resources with the aid of accounting ratio.
HYPOTHESIS 4
H0: Negligence of accounting ratio does not
result to risky and illogical business decisions.
H1: Negligence of accounting ratio results to
risky and illogical business decisions.
HYPOTHESIS 5
H0: Do you think that management, investors,
creditors do not use computed ratio in decision-making?
H1: Do you think that management, investors,
creditors use computed ratio in decision-making?
HYPOTHESIS 6
H0: Accounting ratio does not provide
information about unproductive department.
H1: Accounting ratio provides information about
unproductive department.
HYPOTHESIS 7
H0: The Company does not compute the accounting
ratios.
H1: The Company computes the accounting ratios.
HYPOTHESIS 8
H0: Accounting ratios do not help to discover
strength and weakness of a company and causes, which have contributed thereof.
H1: Accounting ratio helps to discover strength
and weakness of a company and causes which have contributed thereof.
1.7 SCOPES AND LIMITATION OF THE STUDY
The researcher concentrated on accounting ratios
in a manufacturing company. This study
will examine the classification of five accounting ratios; Liquidity ratio,
profitability ratio, activity ratio, leverage ratio and debt to equity ratio.
However, there are some other ratios, which will be discussed in this research
work but could be mentioned later.
Ratios are limited to Nigerian Breweries PLC.
The
researcher in the course of this research was subjected to some constraints.
These constraints include:
(i) Time: The
researcher moved form place to place and time was not on his or her side to
reach all the information she required.
(ii) Finance:
Being a student, the researcher did not have the required cash outlay for data
collection and stationary procurement.
(iii) Insufficient
information: Some officials believe that their financial documents and
information is not for external use.
(iv) Changes in
price level make the analysis invalid: There are decreases and increases in
result of fall and rise in the prices.
(v) The ratios at a point
in time is meaningless unless when compared with another.
(vi) The ratios
are calculated on account of historical (past) financial statements and are not
good indicators of the future.
(vii) The differences
in situations of two firms or one firm over a period of time make comparison
cumbersome.
(viii) Differences that
abound on definitions of terms in the balance sheet and profit and loss account
make interpretations difficult.
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