THE BUSINESS OF FINANCIAL RATIOS AS A TOOL OF EVALUATING THE PERFORMANCE OF A COMPANIES FOR INVESTMENT DECISION
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THE BUSINESS OF FINANCIAL RATIOS AS A
TOOL OF EVALUATING THE PERFORMANCE OF A COMPANIES FOR INVESTMENT DECISION
ABSTRACT
Risks and uncertainties are factors,
which a business must face so long as it remains a going concern. Thus to avoid
the effect of such risks and uncertainties, management and other potential
businessmen are advised to adopt the tool of financial ratios.
The financial ratios will expose the
position of the business in terms of performance and efficiency of operations.
They show whether the management are efficient or inefficient in utilization of
resources such as capital, assets labor etc.
This project work is aimed at
highlighting usefulness of financial ratios as a tool of evaluating the
performance of companies for investment decision.
Chapter one (the introduction) will
explain the meaning of financial ratios, it will go further to state the
purpose of the study, it significance, scope as well as definition of terms
with respect of financial analysis.
Chapter two will deal with the
literature review. Then the study of background of topic will be equally highlighted.
Explanation of selected financial ratios will also be shown.
Coming to chapter three, the
techniques of collection of data and data analytical tool to be used will be
described here. The techniques for collection of data will include the
questionnaire sources. The data analytical tools to be used as percentage size
analysis and chi-square.
Chapter four shows the analysis of
the data collected.
Finally, in chapter five, the
findings be made will be stated, followed by recommendation to ensure effective
and efficient use of financial ratios by users for investment decisions.
Finally the conclusion will inform readers or users that usefulness or benefits
of financial ratios in evaluating performance of companies for investment
decision cannot be over emphasized and that if neglected, the shareholders or
investors will not know their position or fate in companies.
CHAPTER ONE
1.1 INTRODUCTION
Financial
ratios are tools used to analyze financial conditions and performance.
Financial analysis means different things to different people. Trade creditors
are primarily interested in the liquidity of the firm being analyzed. Their
claims are short term and the ability of the firm to pay these can best be
judged by an analysis of its liquidity. On the other hands, the claims of
bondholders are long term. They are interested in the cash flow of the firm to
service debts over a long period of time. The bondholders may evaluate this by
analyzing the capital structures of the firm, the major sources and users of
fund, the firms profitability. Finally, an investor in a company’s common stock
is concerned principally with present and expected future earning as well as
the stability of these earning about a trend. As a result the investor usually
concentrates on analyzing the profitability of the firm (financial ratios)
the point of view of the analyst may be either external or internal. For
external, it involves suppliers of capital while that of internal, the firm
needs to undertake financial analysis in order to plan and control effectively.
To plan for future, the financial manager must assess the firm financial
position and evaluate opportunities in relation to their effects on this
position.
With internal control, the financial
managers is particularly concern with return on investment in the various
assets of the company and in the efficiency of asset management.
Financial analysis involves the use
of financial statement. These statement attempt to several things. They portray
the assets and liabilities of a business firm at a moment in time usually at
the end of a year.
They portray an income statement
which involves the revenue, expenses, taxes and profit of the firm at a
particular period of time usually one
year.
While balance sheet represent a
snapshot of the firm’s statement of assets and liabilities at a moment in time.
The income statement depict its profitability over time.
To evaluate a firm financial
condition and performance, analysis and interpretation of various ratios should
be given to experiment and skilled analyst.
The analysis
of financial ratios involves two types of comparison
1. INTERNAL COMPARISON: Here the
analyst can compare a present ratio with past ratio of the same company. It can
also be computed for projected or perform a statement and compared with present
and past ratio.
2. The second method of
comparison involves comparing the ratio of one firm with those of similar firm
or with industry (this type of comparisons is known as Finding the Industry
average of firm). This comparison gives insight into the relatives of financial
conditions and performance of the firm. But my emphasis in this research work is to limit it to the first
comparison or internal business enterprises have leased to operate or collapsed
as a result of increase in market uncertainties ( with unsteady interest raes
exchange rate, political instability) and inability of some business managers
to use financial ratio effectively and accurately in the assessment of the
performance of their organization. In order to attain the traditional
objectives of maximization of shareholders wealth, the managers should use or
apply financial ratio in taking necessary business decision.
Many banks
have gone distressed because of inability of bank managers to check their
lending by using financial ratio to ensure that they do not go below their
minimum liquidity levels and that of reliable and viable business are given
loans and overdraft.
As a result
of economic hardship and inflation prevailing in the economic, it becomes very
important that an effective and reliable means of evaluating the performance of
companies for investment decision should be adopted any management shareholder creditors
and even general public. Financial ratios analysis is one of the major
techniques and in evaluating performance of business organizations.
Financial ratio exposes the
position of the business in terms of performance and efficiency of operation.
They show whether the management
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