ANALYSIS OF FINANCIAL STATEMENTS AS AN AID TO MEANINGFUL INVEST DECISION MAKING (A CASE STUDY OF INVESTMENT FIRMS IN ENUGU STATE)
This chapter is converted with the review of the body of knowledge that has been accumulate din this area of study. In order to understand analysis of financial statements and the basic objectives and methods of preparing financial statements and the underlying concepts, is essential that one should be above to interpret information to appreciate relationship between the alternative available from analysis of financial statement, gasp their significance and evaluate the importance of the apparent results.
According to Asechemic (1990:302) “financial statement analysis consist of the effect to drive meaning from set of financial statement.” Arguing further, he stated that traditionally, most of these analysis are done through the computation and evaluation of ratios, which relate pairs of financial statements numbers one to the others.
According to Briggs and Perrins (1971: 39) “Accounting ratios are techniques used to facilitate compassion of significance figures by expressing their relationship as ratios or percentage and so enabling the account of a business to be interpreted by bringing into focus the salient feature.
Ola (1987:463) stated that “ratio analysis is a useful techniques which serves as an aid to the interpretation of accounting information because they help analysts to make logical deductions about the situation presented by accounts”.
When analyzing financial statements in any debt it is necessary to compare a good number of ratios because ratio analysis is the most widely used approach for interpreting and comparing financial reports. Ratios are used to summarize briefly relationship and results, which are significant to an appreciation of critical investment opportunities available at any point in time. Ratios must be compared with investment demands and benefits for meaningful investment as well as risk associated as to make deductions from meaningful investment decisions.
In some cases it is necessary to project trend into future. For example, an analysis might reveal that investment has steadily been doing well in the area of sales increment over the past few years. A potential investor might deduce from this and make meaningful decisions towards sales strategy in an investment approach. Writing on raitos, Sidney et al (1988:802) state that “Financial statement prepared for external uses are analyzed by investors, banks and other in making their investment, credit and similar decisions”
This equally comprises the idea and significant of analysis of financial statements of meaningful investment decision making.
Furthermore, Osiegu (1991:91) defined financial ratios as “An expression of the relationship between two accounting measurements.” He went further to work with the reported financial ratio analysis is useful in that it provides guidance discipline to the analyst.
It provides information about a number of different relationships that are highlighted in an investment opportunity. Financial statement analysis is an attempt to work with the reported financial figures in order to ascertain the investment strength and weaknesses.
2.1 REVIEW OF FINANCIAL STATEMENTS
To study financial analysis, it will be of importance to make adequate considerations of financial statements from which the ratios are computed.
According to finnerty (199:779) “The primary source of financial statements; the information obtained in this statement summarizes the financial performance and financial position of the firm.
From the above, it can be deduced that with information gathered from analyzed financial statements, the need and the risk associated or imminent in the financial aspect of investment is brought to lime light thus giving way for meaningful decision making, for successful realization of investment goals through implementing such decisions as corrective measure and for potential investor, the ability to make a choice among accessible opportunities.
Writing on financial statement Ikoku (1993) noted that financial statement underlying purpose is to periodically covey to shareholders and other invested parties the following:
- Basic accounting information which saves as a measure of company’s (investment) financial progress and condition.
- Economic results of its activities and
- Supportive analysis of the changes in the components of the firms financial structure and lead of risk.
She went further to state that its component includes:
- The chairman’s Board of Director’s statement
- The auditors report
- Graph and figures
- Table of Accounting data
The information needed by investors for their investment decision is satisfied by the company through the publication of the financial statements. Paraggraph (2a) of company and Allied Mater Decree (CAMD) 1990 requires that company disclose with reasonable accuracy at anytime, the financial statements through which information of the company’s activities should be revealed. The statements includes:
- Statement of accounting polices
- Balance sheets as at the last day of the year
- A profit and loss account
- Note to the account
- The Auditors Report
- The Directors Report
- The statement of sources and applications of fund
- A value added statement for the yea
- A five-year financial statement
- In case of a holding company, the group financial
statement in addition should be disclose in the proper form and content.
For the purpose of this research study, we shall put emphasis on the balance sheet, the profit and loss account, the source and application funds and the notes to the accounts.
2.2 THE PROFIT AND LOSS ACCOUNT OR INCOME STATEMENT
According to every and Farely (1991:780) “The income statement reports the profit (or loss) performance of a business entity for a specific period of time, usually a year or more portion therefore.” Net income or net profit is the difference between total revenues and total cost for the period. For an investor, net income shows benefits or stands for benefits realized by investing in a particular investment opportunity. High net incoem increases the zeal to invest while loss an investment negates the propensity to invest.
Certain non-cash items such as depreciation and amorlization are deducated from revenue in erruine at net income. The residual amount earnings available for common stock is available for payment to common stock.
Earnings per share and in some cases dividend per share are provided at the foot of the income statement. The income statement seems to highlight the company’s earnings per share. Indeed that figure and its rate of growth overtime are the most widely used measure of company’s investment potentials of its common stock.
Financial analysts find if useful to examine the profitability ratios. By calculating profitability ratios that express the profit earned by the firm as a percentage of various variable and courage ratio that measure firms ability to meet its interest preferred stock dividend obligation.
- NOTES TO THE FINANCIAL STATEMENT
The notes to a firm’s financial statements are integral parts of statements of the firm that disclosed the important accounting policies that are used to prepare the financial statement for the firms and other additional detail concerning several of the items in the financial statement which include:
- Description of the earnings per share calculated
- Break-down of investors
- Cost and amount of short-terms borrowing
- Details concerning significant acquisitions or disposal of assets
- Commitment and contingent liabilities
- More detailed break-down of income interest and other financial changes and provision for income taxes.
- A five (5) year summary comparison of financial performance and positions
- Depreciation policy
- Foreign exchange translation
From the above listed items, it is clear that notes to a firm’s financial statement contains a wealth of information that is useful is financial statement analysis using accounting ratios
- BALANCE SHEET
A balance sheet is equally an integral part of financial statement that reports entity’s financial position of a particular point in time. It provides a list of resources possessed by an entity and claims of creditor (s) against the resources. The statement itself is sometimes referred to as a balance sheet, a statement of financial position or statement of financial condition.
The major importance of balance sheet is that it serves as a critical indicator of the basic credit strength of company and therefore the company’s capability of financing itself. It shows on a historical cost basic the assets of the firm which stands as the resources utilized in its operations as well as stock holders equity and liabilities of the firms, which are the total claims dividend between the claims of creditors and those of the owners against those assets. The identifies of balance sheet are as follows:
Assets = liabilities + stock equity.
- STATEMENT OF SOURCES AND APPLICATIONS OF FUNDS
The funds is one of the sources and application of funds is one of the systems f accounts in which interested parties are shown the various ways through which funds have been derived and utilized for business operations in particular accounting period. It is the statement that reconciles changes in the balance sheet and income statement. Specifically, it explains why differences occur between ending balance sheet of company and the profit made within the same account period and equally period information to help assess the liquidity position of a firm.
- OBJECTIVES/USEFULNESS OF FINNCIAL
The publication of financial statement by a company (in accordance with the legal requirements of the establishment of company) serves a purpose if it fulfils the objective and reason for publication. The satisfaction of the need of the various uses of accounting information contained in the annual report can be accepted as the objective of financial statements.
Lun (1979:27): The objective of financial information emphases by the various accounting that is useful to present to potential investors in making rational investment decision.
Accounting to Anderson et al (1981:544) :for financial reports to be useful and relevant, these reports as a primary means of communication between the business enterprise and share holders (investors) must both be read and understand. To achieve users comprehension of the economic message.
Financial statement should be comprehensive to investors or users who has reasonable understanding of business and economic activities and who are also willing to spend time and effort needed to study financial statement. In addition, it is through the use of financial reports that use can assess the prospect of receiving cash from dividend or interest and processed form sales, redemption, or maturing of securing or loan.
Elis (THACKER (1980:21) “the most important purpose of annual report is to give the share holders (investors) information about financial standing of his company., especially as to its income and financial position”.
Day (1986:36) “Since the usefulness of financial information to investors are affected by: its ability to obtained enough cash through earning and financial activities to meet obligation when due, ability to reinvesting earning resources and to pay cash dividend as perceptions of investors and creditors generally.
The perception of investors about a company’s ability affects the market price of the company’s securities relative to other in the industry. It is necessary to understand that financial statements can only be useful to investors to analyze them in order to make effective use of them.
Annual reports contain a detailed analysis of full years economic activities that could be revealed by any source as the most useful source of investment decision. However, according to Day (1986:26) it is difficult to assess the usefulness of financial reports to investors directly, the reason being that in general, investor seem to make a little use of annual report possible because they appear not fully understand. Therefore understanding the information in financial statement is crucial to the effective utilization of information contained.
On the issue of perception and use of the financial reports, Taylor et al (1986:54) observed in their work that some investors who attach a little importance to financial reports assume that before these reports are realized, they advise investors against such practice arguing that such reasoning is myopic and this set of investors has simply ignored the probability that annual returns contains incremental information. They further explained that by incremental information, they meant information content of the data contained in the financial statement to present to potential investors which have not been preciously released to public.
In conclusion, it is advised that when the financial report satisfies its objective, proper attention must be paid to derive maximum usefulness from it.
- THE NEED FOR ANALYSIS OF FINANCIAL STATEMENT
Financial statements are the primary sources through which investors are informed on the activities and operations of the companies in which they invested in or tend to invest in, as in the case of potential investors. The need to analyze financial statement for investors have been clarify stated in the objectives of financial reporting above.
The notes to accounts are referred to in the body of the financial statement. In fact, they give more explanation on what is contained in body of account.
According to Syyode (1982:20) it is important to study the notes to the financial statement carefully because the more one ignores the notes, the less adequate information one gathers from the accounts. The notes explain the accounting terms and discloses limitation imposed by contingent liabilities. It also give explanation where there have changes in methods and polices that would make comparison of the result less reasonable.
The need for he use of financial statement analysis by investors cannot be over emphasized as it make for a letter understanding of the companies operations and hence gives investors a clear course of action.
Financial statement as earlier mentioned, is analyzed through computation of ratios, with such ratios computed; investors are exposed and can be able to assess available investment opportunities.