THE USEFULNESS OF FINANCIAL STATEMENTS IN ASSESSING THE PERFORMANCE OF COMPANIES AND IN GUIDING INVESTMENT DECISIONS

CHAPTER ONE

1.0              INTRODUCTION:

1.1       BACKGROUND OF THE STUDY:

A company’s financial statements are analyzed internally by management and externally by investors and creditors.

Management analysis of financial statements primarily relates to parts of the company which enables management to plan, evaluate, and control operation within the company.  Investors and creditors generally focus their analysis of financial statements on the company as a whole, which helps them decide whether to invest in or extend credit to the company.

As a minimum, financial statement will include a statement of source and application of funds.  Having been able to obtain a fair knowledge of the legal aspects of preparing financial statements and having worked examples through basic financial statements of a company, it is reasonable to begin to think of the significance of the futures therein.

His is because except the figure in financial statements will not in itself serve any purpose, the figures in the financial statements are therefore:

(a)                How well or badly the company is performing.

(b)               How financially strong or otherwise the company is.

(c)                How valuable or otherwise the company is in terms of its assets base.

Unless a means is available for being able to obtain the information specified above a financial statement would just be of no substance and use.

In order therefore to interpret financial statements for the proper information of users, there is the need to proper ratio analysis and when to present to management, a number of issues must be considered.

These include:

(a)                Profitability of the business, operations, particularly in relation to capital employed.

(b)               Solvency of the firm:  The ability of the business to pay its creditors the adequacy of its working capital and the liquidity of its current assets viewed side by side with the current liabilities.

(c)                The business trend:  An analysis of the pattern of business overtime to determine whether profits are rising or falling and the implications for future performance.

(d)               The gearing and cover:  Assessing the adequacy of profits to meet interest payments, pay dividends to shareholders’ investment.

1.2              STATEMENT OF THE PROBLEM:

This research work intends to look into the extent to which investors do carry out and rely on the results of financial statements analysis before making their investment decisions, and the employment by companies of financial statement analysis in assessing their performance and that of their respective management.

1.3              OBJECTIVES OF THE STUDY:

The objectives of this study are as follows:

(a)                Financial statement analysis consists of applying analytical tools and techniques to financial statements and other relevant data to obtain useful information.

(b)               This information is shown as significant relationships between data and trends in those data that assess the company’s past performance and current financial position.

(c)                The information shows the results or consequences of prior management decisions.

(d)               In addition, the information is used to make predictions that may have a direct effect on decisions made by users of financial statement.

(e)                Present company investors and potential company investors are interested in the future ability of a company to earn profits – its profitability.

1.4              SIGNIFICANCE OF THE STUDY:

This work would be of immense benefit to the following groups:

1. Financial analysts
2. Economic researchers and students.
3. Investors and shareholders
4. creditors

The major contribution of this work are:

1. To the management of companies as a tool for evaluating their performance and knowing whether they really take not of financial statements.
2. to further examination of the use of financial statement.
3. to other researchers or research scholars who may wish to carry out further research on the subject matter or other related topics.
4. it will provide insight on how business organization rely on financial statement for decision making.

1.5              SCOPE AND LIMITATION OF THE STUDY:

This study is restricted to only the analysis of the financial statements of manufacturing, trading and profit making organizations.  The researcher would have liked to give the work a wide coverage if not for some constraints imposed on hereby time and access to finance.

1.6              RESEARCH QUESTIONS:

The following research questions will be used to get information for the purpose of evaluating the usefulness of financial statements in assessing the performance of companies an in guiding investment decisions especially as it affects Onitsha Aluminium company in particular. 

1. Do you have any sales and purchases?
2. Are expenses authorized or approved before they are incurred?
3. Any profit and loss account?
4. In what ways do accounting techniques help business organization in determining their financial position?
5. how can financial statements be used in assessing the performance of companies for efficient investment/management decisions?
6. Can firms or companies do without financial statements in their investment decisions?

1.7              STATEMENT OF HYPOTHESIS:

Hypothesis testing will involve the use of null hypothesis (Ho), the study is seeking to reject.  It’s rejection will lead to the acceptance of the alternative hypothesis (H1).

Ho:      Financial Statements do not help in guiding investment decisions.

H1:      Financial statements help in guiding investment decisions.

Ho:      Financial statements are irrelevant in assessing the performance of Onitsha Aluminium Company.

H1:      Financial statements are very relevant in assessing the performance of Onitsha Aluminium Company.

1.8              DEFINITION OF TERMS:

1. FINANCIAL STATEMENTS:  These are used to convey a concise picture of the results of operations and the financial position of a business in a given accounting period usually 12 months that is a year.
2. PERFORMANCE: Consisting of a comparison of actual outcomes (actual costs and revenues) and planned outcomes (budgeted costs and revenues) at a regular intervals usually a 12-month that is a year.
3. COMPANY:  Is a separate and distinct entity from its members (shareholders) with a corporate name in which it can sue and be sued, own property and enjoy contractual capacity.
4. AN INVESTMENT:  Is regarded as the commitment of current funds in anticipation of receiving a larger future flow of funds OR is ploughing one’s funds into projects or assets with a view to increasing one’s wealth.
5. DECISION:  Is the selection or choosing among the alternative courses of action that will enable the objective to be achieved OR as making choices between future, uncertain alternatives.

USEFULNESS:  Is something which can be used for some practical purpose, serviceable, helpful or worth keeping.  OR is any information kept in an organization which serve for future purpose(s) and assist in decision making.