Analysis of Financial Statements for Investment Decision
Analysis of Financial Statements – Financial statement objectives are to provide information about the financial performance, position and stability of an establishment which is useful to wide range of users in making economic decision. The statement of principles emphasize the key characteristic of the information contained in the financial statement is that it should be useful.
Financial statement including the final account of business are produced not merely for their own sakes but for the uses to which they can be put by the various parties interested in different aspect of the financial statement.
The preparation of a company financial statement are regulated by the companies and Allied matter Act 1990 (CAMA 1990) as amended and the accounting standards for example, section 331 of CAMA 1990 provide the procedures which management of every registered public limited liability company should follow in the preparation of their financial statement. Section 334 of CAMA 1990 also provide the duties of the directors in preparation of financial statement. In the same vein, section 342 of CAMA 1990 provide reporting standard of the directors of the financial statement prepared. On the other hand accounting standard set the underlying standard for the preparation of financial statement.
The sole aim of preparing financial statement is to report to the shareholders which are the owners of the company on the financial performance of the company. When shareholder receive the financial statement of the company they have invested in. most of them simply look to see whether the business has made profit and then put the document away. They are aware of only one thing that is, that the company has made profit. They do not know if it was a “good” profit nor do they know whether there was any deferent from the profit earned in the previous years.
By human initiatives there might be the tendency of the management preparing progress statement of account to suit their own interest instead of giving proper and correct information to the owners and investor s. The management annual financial statement may contain error and may not disclose all information required by law. In respect to this, audit of the financial statement is the therefore necessary so as to show that the financial statement shows a true and fair view.
It is quite unfortunate that a lot of companies still go into liquidation despite such clear Audit report of financial statement. The research work is designed to analyze the financial performance of company.
BACKGROUND OF THE STUDY
Zenith bank Plc was chosen as the studied area of the project. Zenith Bank Plc was incorporated (under the companies and Alllied Matters Act 1990 as Amended) on may 30, 1990 as a provate company limited by shares and commenced operation on July 16, 1990. The name of the bank was changed to Zenith Bank Plc on 20 May, 2004.
In July 2004, the bank became a public company limited by share and subsequently lunched what still remain the most successful initial public offer (IPO) in the history of the Nigeria capital market. It received an overwhelming investor affirmation by a subscription rate of 556% and about 289, 489 subscribers.
The bank achieved another Mile Stone when it raised #53.63 billion in February 2006 by a public offer of three billion shares, one of the largest amount in the history of the Nigeria Capital Market, with over one hundred and eighty (180) business offices, connected on line-real time, the bank franchise covers all the state capitals, the federal capital territory (FCT) and major towns, and cities in Nigeria.
Zenith Bank Plc is one of the largest and most profitable bank (Post consolidation) in Nigeria with total assets plus contingents of over #714.5 billion as at 30 June 2006. The operating result for the year ended 30 June 2006 showed that the profit before tax was #15.2 billion while it shareholder fund stood at #93.8 billion.
The Bank has four subsidiary companies namely, Zenith Securities limited, Zenith General insurance company limited, Zenith Bank Ghana limited and Zenith Pension Custodian Limited. The bank also acquired significant share holding in seven companies incorporated in Nigeria, Qubit Spectrum limited, Venus telecom Limited, Cyberspace Network limited and Omatek Computer limited under the small and Medium Enterprises Equity Investment Scheme (SMEEIS).
The bank has been conferred with several Awards including Bank of the year 2005 by the Banker Magazine financial times of London and this Day Award of or excellence and also the Best bank Website in Nigeria (2003, 2005) by Philips consulting, best custom Duty collection Bank 2000-2005 by Maritime Quality services Award, and many others.
Zenith Bank growth and performance has earned excellent rating from both local and international rating agencies. The bank has been rate Aaa in Nigeria consecutively for the past six years by Agusto BCo Ltd. It also has the lowest Non-performing loans to total loan ratio of 1.7% against the industry average of 18% and has grown its asset base advantage of over 50% per annum in the last five years. It is as been rated by pharez composite rating as a bank of excellent financial condition with enormous capacity to meet the maturity obligation as they fall due.
THE BOARD OF DIRECTORS
The board of directors comprise of:
| Macoulay pepple | Chairman |
| Jim Ovia | Managing Director. Chief Executive |
| Godwin Emefiele | Deputy managing Director |
| Chief Eddy M. Egwuenu | Director |
| Sor S. P. O. Fortune Ebie | Director |
| Sir Steven Omojafor | Director |
| Professor (Prince) L. F. O. Obika | Director |
| Babatunde Adejuwon | Director |
| Peter Amangbo | Executive Director |
| Elias Igbin Akenzua | Executive Director |
| Apollos Ikpobe | Executive Director |
STATEMENT OF PROBLEM
In past year most investors and other financial statement user see the financial statement prepared by a given company and they either invest or give loan to the company and after a period of time, the company fold-up and their money is gone. This could be partly because the investor and other financial statement user do not have the knowledge of accounting which enable them to analyze and appraise the financial performance of the company through their published financial statement.
The problem is the inability on the part of the investor shareholder and other users of financial statement to analyze the financial statement of companies.
Such problems are:
(a) The problem of the share holders of Zenith bank Plc not being able to apply ratio calculated for comparison with past ratio of the bank and comparism with other similar banks.
(b) Inability to calculate ratio and be able to interprete and analyze the financial statement.
(c) The shareholders, lenders, investor’s ignorant of analyzing financial statement using ratio as a basic tool.
The financial performance of companies cannot be understood from their published financial statement by investors by mere looking at the financial transaction that are contained in the financial statement. This makes some investor become worried whether to invest or not in a company.
The objective of the research work is to improve the general understanding of the shareholders and other users of financial information on the analysis of financial statement to be able to invest in companies. It would be designed to help the users of financial statement to enable them appraise the performance of the company and be able to make right decision as to whether to continue to invest in such company or disinvest. In other to achieve the objective of this research work, the researcher would make use of ratio analysis as a basic tool in appraising and analyzing the profit and loss account and Balance Sheet of Zenith Bank Plc.
Those who will benefit form the research study ranges from the shareholders, investors, government, authorities, competitors, creditors etc since financial statement of a company is what gives financial information to the users of such statement. The users can appraise and analyze the financial statement and be able to make right decision whether to continue to invest in such company or not. The research study would also contribute to the efficiency of the management of such companies in order to ensure proper internal control system that will enhance non-misleading financial statements.
RESEARCH QUESTIONS
Section 331 of CAMA, 1990 laid down the procedure which every registered limited liability company should follow in preparing their financial statement but most companies published financial statement do not reflect the actual state of affair of such company.
Research question in this research are meant to provide dependable solutions to the following questions:
(a) What content of financial statement is analyzed using ratio analysis?
(b) Does the analysis of financial statement have any relevance to the users?
(c) Do bank prepare financial statement for internal or external use?
(d) How can ratio analysis influence a share holder to invest in a company?
(e) How can the performance of a company be determined?
FORMULATION OF HYPOTHESIS
Base on the statement of problem, the following null hypothesis were empirically formulated and tested on the analysis and interpretation of financial statement.
(1) Ho: The Inability of the interpretation of ratio analysis computed leads to improper assessment of a company.
H1: The Inability of the interpretation of ratio analysis computed cannot lead to improper assessment of a company.
(2) Ho: Ignorance of the application of ratio analysis to evaluate a company’s performance leads to wrong investment decision.
H1: Ignorance of the application of ratio analysis to evaluate a company’s performance cannot lead to wrong investment decision.
(3) Ho: Ratio analysis computed using wrong formula hinder right result thereby leading to wrong investment decision.
H1: Ratio analysis computed using wrong formula cannot hinder right result and cannot lead to wrong investment decision.
RESEARCH METHOD
This has to do with the systematic process or procedure designed for generating collecting and analyzing the data required for the research work.
In respect to this, the researcher would make use of appropriate statistical method of data collection.
LIMITATION AND DELIMITATION OF STUDY
This study has been undertaken in spite of cynicism that dogged the study right from conception which constituted limitation to the researcher and these are:
TIME FACTOR:
As a result of other academic work coupled with shortness of time given for completion of this research work, the researcher had to battle with the limited time available to him in combining traveling to the place of case study and attending lectures.
POOR RESPONSE FROM RESPONDENTS:
The attitude of some of the respondent and some library attendant probably due to ignorance also constituted its own limitation.
FINANCE
Numerous expenses were involves in this work, hence the limited resources available to the research due to poor economic condition was not enough to take care of the high transportation cost, stationeries, public relations and cost of typing this work and binding it. The research study covers the analysis of the financial statement of Zenith bank Plc for five years.
In the analysis the basic techniques in use is ratio. The researcher would limit this study to the analysis of profit and loss account and balance Sheet of Zenith bank Plc for five Years.
The following terms were used in this study as defined to facilitate the effective communication of the study.
(i) FINANCIAL STATEMENT: These are document prepared by the management of a company to communicate its performance to the shareholder and other users.
(ii) INVESTMENT: This means the forfeiture of the present resources for the future. It is the commitment of present resources for future return.
(iii) MANAGEMENT: These include board of directors, the general manager, the functional manager and divisional managers.
(iv) Ratio: This is the term that expresses the relationship between two financial data that is useful in the assessment of a company performance.
(v) CAMA, 1990: These are act or statute that regulates the operational activities of companies.
(vi) DATA: This is an unprocessed (raw) input to the management of a company.
LITERATURE REVIEW
The nature and objective of financial statement, usefulness of financial statement to general user group, the characteristics of useful information contained in financial statement, the element of financial statement, the companies Act and the Publish financial statement and the underlying assumption. The financial statement and the effect of different accounting policies. All these would be review and focus on in this chapter.
The description of investment decision, tools for evaluating investment decision, importance of ratio analysis, classification of ratio and validity of ratio analysis in investment decision would also be reviewed.
THE NATURE AND OBJECTIVE OF FINANCIAL STATEMENT
An establishment communicates its financial information to the users through financial statement and report. The financial statement of a company contains a summarized information of the company financial affairs organized systematically. Financial statement including the final account of businesses are produced not merely for their own sakes but for the uses to which they can be put by the various parties interested in different aspects of these statement.
Financial statement prepared for this purpose meet the common needs of most users, however, financial statement do not provide all the information that users need to make economic decision since they largely portray the financial effect of past event and do not necessarily provide non financial information.
According to Portar And Nurton (1995:54) financial statement has one overall objective and a set of related objectives that follows from it.
The primary objective provide information for decision making. The primary objective of financial reporting is to provide economic information to permit users of the information to make informed decision. Users include both the management of a company (internal users) and others not involved in the daily operation of the business (external users) without access to the detailed records of the business and without the benefit of daily involvement in the affairs of the company. External users rely on general purpose financial statement prepared by management to make their decision According to the financial standard Board (FASB).
Financial statement should provide information that is useful to present and potential investors, creditors and other users in making rational investment, credit and similar decision.
(a) Reflect prospective Cash receipts to investor and Creditors financial statement provide information to help present and potential investors and creditors and other users in assessing the amount, timing and uncertainty of prospective cash receipts from dividends or interest and the proceed from the sales, redemption or maturity of securities or loans.
(b) Reflect prospective cash flow to the enterprises: Another objective of accounting is to provide information that will allow users to make decision about the cash flow of a company. This does not mean, however that a company should use a cash basis of accounting to attain this objectives certainly the cash flow statement provide useful information in making decision about the cash flow of a company in the future. However, income statement and balance sheet prepared using the accrual basis accounting are better indicators of the ability to generate favorable cash flow than statement limited to the effect of cash inflow and outflows.
(c) Reflect resources and claim to resources: the Financial and Accounting Joint Board (FAJB) has emphasized the roles of the balance sheet and income statement in providing useful information, financial reporting should provide information about the economic resources of an enterprise, the claim to those resources (obligation of the enterprise to transfer resources to other entities and owner’s equity), and the effect of transaction, events, and circumstance that charge resources and claim to those resources.
USEFULNESS OF FINANCIAL STATEMENT TO GENERAL USER GROUP
The Corporate report published in 1975 by the Accounting Standard Clearing committee (ASSC) identified seven separate users groups of financial statement are as follows
(1) THE EQUITY INVESTOR GROUP: Essentially this group consists of existing and potential shareholders. This group is considering whether or not to buy more shares or not to buy more shares; or alternatively whether or not to disinvest, to sell shares in the business. Equity investors look for one or a combination of two things income a money return by way of dividend or capital gain a money return by way of selling shares at more than purchase price.
(2) LOAN CREDITOR GROUP: This group consists of long medium or short term lender of money. According to the subdivision suggested by the corporate Report, trade creditor are not included here, but only explicit i.e. deliberate loan creditor. The crucial question an existing or potential loan creditor wishes to consider is obvious: will he or she get their money back? A short term loan creditor will primarily be interested, therefore, in the amount of cash a business has got or will very so on get. As a safeguard they will also be interested in the net reliable value (NRV) of all the assets and the priority of the various claims other than their own on the available resources, long term lender will clearly need a corresponding long term view of the firm future cash position.
(3) THE EMPLOYEE GROUP: Employee or their representatives need financial information about the business for two main reasons:
(a) Fair and open collective bargaining (i.e. wage negotiation)
(b) Assessment of present and future job security.
In this respect they too need to be able to assess the economic stability and vulnerability of the business into the future.
(4) THE ANALYST ADVISER GROUP: In one sense this is not a separate group. It is a collection of experts who advise other group stock brokers and investment Analysts will advise shareholders, trade union will advise employees, government statistician will advise the government ands soon the need of the analyst-adviser group are obviously essentially the need of the particular group they are advising. However, being adviser and presumably expert they will need more detail and more sophisticated in the information presented to them.
(5) THE BUSINESS CONTACT GROUP: As defined in the corporate Report this is rather a rag-bag group, it consist in effect of all those who have or may have dealings with the business but who are not included in any other group, it can usefully be divided into three subgroups:
(i) Supplies and trade creditor need similar information to that required by short term loan creditor. But they will also need to form a long-term impression of the business future.
(ii) Customer will wish to asses the reliability of the business both in short term sense (will I get my goods on time and in good condition) and in the long term sense (can I be sure of after-sales services and an effective guarantee?) Where long-term contract are involved, the customer will need to be particular on his her guard to ensure that the business appear able to complete the contract successfully.
(iii) Competitor and business rival will wish to increase their own effective and efficiency by finding out as much as possible about the financial, technical and marketing structure of the business. The business itself will naturally not be keen for this information to become generally available within the industry and it is generally recognized that business have a reasonable right to keep the causes of their own competitive advantage secret.
(6) THE GOVERNMENT: Everybody is aware that government require financial information for purpose of taxation. This may be the most obviously apparent use by government but it is not necessarily the most important Government also need information for decision making purposes. Government today take many decision affecting particular firm or particular industries both in a control sense and in government capacity as purchased or creditor. Also government needs information on which to base their economic decision as regard the economy as a whole.
(7) THE PUBLIC: Economic entities i.e. business in the broadest and most general sense, do not exist in isolation. They are part of society at large and they react and interact with society at every level. At he local level they have concern at such things as employment. Population, health and safety. At the wide level, there may be interest in for example energy usage, effective use of subsidies, dealing with foreign government and contribution to charities in money or kind. Much of this information is non-financial. Indeed some of it cannot be effectively measured at all. Whether if accounting information is an open question. But it is certainly a useful information about business.
CHARACTERISTICS OF USEFUL INFORMATION CONTAINED
The corporate report suggest Seven (7) Characteristics of useful information which include:
(1) Relevance
(2) Understandability
(3) Reliability
(4) Completeness
(5) Objectivity
(6) Timeliness
(7) Comparability
Also Frankwood (2005: 152) Financial statement should contain information that is useful. Information is useful if it is relevant, reliable, comparable and understandable. The four term are defined by Accounting Standard Board (ASB) as follows:
(1) RELEVANT: Information is relevant if it has the ability to influence the economic decision of users and is provided in time to influence those decisions.
(2) RELIABLE: Information is reliable if:
(a) It can be depended upon to present faithfully what is either purports to represent or could reasonable be expected to represent and therefore reflects the substance of the transaction and other event that have taken place.
(b) It is completely and is free from deliberate or systematic bias and material error.
In its preparation under conduction of uncertainty, a degree of caution has been applied in exercising the necessary judgments.
(3) COMPARABLE: Information is comparable if it enables users to discern and evaluate similarities in, and differences between, the nature and effect of transactions and other event over time and cross different reporting entities.
(4) UNDERSTANDABLE: Information is understandable if its significance can be perceived by user that have a reasonable knowledge of business and economic activities and accounting and a willingness to study with reasonable diligence the information provided.
The corporate report (1975) added objectivity, completeness and timeliness.
The information presented should be objective or unbiased in that it is should meet all proper user needs and neutral in that the perception of the measurer should not be biased toward the interest of any one user group.
The information presented should be complete. The user should be given total picture of the reporting business as far as possible.
It must be provided in time. This means that the information should be provided to the user in time for use to be made of it. Information presented should be as up to date as possible.
“Approximate information made available in time to assist with some decision or action is likely to be more useful than precise and accurate information presented after the decision has already been made”
ELEMENT OF FINANCIAL STATEMENT
According to Alexander and Britton (2000: 144) The word “element: came from a publication by the American federal According standard board (FASB) as part of their conceptual framework project, element of financial statement of Business Enterprises (December 1980). Element are defined in the report as follow.
“Element of financial statement are the building blocks with which financial statement are constructed class of statement are constructed. The class of item that financial statement comprise the item in financial statement represented in words and numbers certain enterprise resources, claims and the effect and the effects of transaction and other event and circumstances that result in changes in those resources and claims”
The following items discussed below are found in financial statement Robert O. Igben (1999: 34, 35, 36)
TRADING AND PROFIT AND LOSS ACCOUNT ITEMS
Gross Profit: This is the project earned on goods sold during the period it is shown in the format of the trading account obtained by deducting cost of goods sold (or cost of sales) from the sales value.
NET PROFIT/ LOSS: This is the profit obtained in the profit or loss account after adding incomes (other than from sales) to the gross profit and deducting them from the indirect (i.e. overhead) expenses. Net profit is therefore the excess of all income over all expenses. Conversely the excess of all expenses over all income is net loss.
REVENUE/ INCOME: These are the amount earned by a business organisation during the period. The major source of income for a sole trade is the sale of goods income from sale of goods is dealt within trading account while income from other sources such as interest received on bank deposit, discount received and rent received are dealt with in the profit and loss account.
EXPENSES: These are the cost of goods and services consumed during the accounting period. They are the cost incurred in the operation of the business organisation during the period. Expenses that are direct in nature (example purchase price of goods sold and carriage inward costs) are dealt with in the trading account while expenses that are indirect in nature (i.e. over head expenses) such as rent and rate depreciation, transport and traveling and salaries are dealt with in the profit and loss account.
BALANCE SHEET ITEMS
ASSETS: Assets are resources owned and used by a business organisation for the purpose of generating income. An asset yields future economic benefit to the business organization owing it. Asset may be fixed or current.
FIXED ASSET: These are assets whose useful economic life does not exceed one year i.e. the business organisation will enjoy the benefit form he ownership and use the asset for years example include furniture and motor vehicles.
CURRENT ASSET: These are asset whose useful life does not exceed one year. They exist for only a short time before they are transformed into other kind of assets. In other words, the composition of current asset is constantly changing. They change from cash at bank in hand to stock then to debtor and prepayment and back to cash at bank or in hand many times within one accounting year. This is why they are sometimes refers to as circulating assets.
The above classification of asset is according to their permanence. Asset can also be classified according to their nature as follows:
TANGIBLE ASSET: These are assets that can be seen and touched e.g. motor vehicle and stock
INTANGIBLE ASSETS: These are assets that can neither be touched nor seen but are valuable to the business example trademark, patents, and goodwill.
FICTITIOUS ASSET: these are items that have characteristics resembling those of assets but are not assets in the true sense of the word. They are debit balances that have no realizable value to the organisation. Example include accumulated losses brought forward and preliminary expenses which are shown on the balance sheet but are to be “written of” as soon as there is sufficient profit (or reserves) to absorb them.
WASTING ASSETS: These are asset whose value becomes exhausted or consumed as a result of being worked examples are mines and quarries.
LIQUID ASSETS: These are cash in had or at bank other items such as marketable short-term investment which can be quickly turned into cash,
LIABILITIES: These are amount owned by the business liabilities represent the claim by outsiders over the assets of the organisation, liabilities can be classified according to the time frame within which they fail due as follows:
LONG TERM LIABILITIES: These are liabilities which fall due after more than one year example debenture and bank loans.
CURRENT LIABILITIES: These are liabilities which fall due within one year. Example include trade creditor, bank overdraft and accrued expenses.
Other kinds of liabilities normally encountered in financial accounting are provision and contingent liabilities.
PROVISION: The definitions of provision are contained in paragraph 82 part V of schedule 2 of the company and Allied Matter Decree (CAMD) 1990. Two type of definition are given in that paragraph they are:
(I) Provision for depreciation and diminution in value of asset.
“Any amount written off by way of providing for depreciation and diminution in value of assets”
Example include provision for depreciation, provision for bad and doubtful debt and provision for discount on debtor on the balance sheet, these provision are deducted from the assets to which they relate. Provision of depreciation is deducted from the cost of fixed cost to obtain the net book value of the assets while both provision for bad debts and provision for discount on debtors are deducted from gross value of debtors to obtain the realizable value of debtor.
(II) Provision for liabilities and Charges:
“Any amount retained as reasonable necessary for the purpose of providing for any liabilities or loss which is either likely to be incurred or certain to be incurred but is uncertain as to the amount or as to the date which it will arise”
Example include provision for deferred taxation, provision for pension costs, provision for redundancy and provision for reluctances and provision for respires and maintenance. These are not on the balance sheet, deducted from any asset. They are rather disclosed separately at liabilities.
CONTINGENT LIABILITIES: These are liabilities, the occurrence and amount of which depend on some uncertain future event(s) since the liabilities does not actually exist at the balance sheet date and its future occurrence is not even certain, it is not normal to show contingent liabilities on the balance sheet the way provision and accrued expenses are. Rather, the estimated amount of the contingent liability is disclosed by way of note to the balance sheet. Example include damages which may be awarded against the business organization when judgement is eventually entered in a litigation pending as at the balance sheet date and discounted bills of exchange.
WORKING CAPITAL: This is the excess of current assets over current liabilities. Alternatively, working capital can be described as net current assets.
CAPITAL: From the limited liability company point of view, capital is the total fund contributed by the share holders (more appropriately described as share capital). This fund is subsequently increased by the undistributed profit while it is decreased by the losses of the company. In a company the sum of the share capital and undistributed profit is known as shareholder fund which is the claim of the shareholder over the assets of the company.
THE COMPANY ACT AND PUBLISHED FINANCIAL STATEMENT
The Company Allied Matters Act 1990, as amended in modern company legislation it contain several detected disclosure requirement but mot importantly, it had overriding requirement that financial statement show “ A true and fair view”. This is expressed in section 334 of CAMA, 1990. it is the duty of director of every company to prepare the financial statement for each year of the company.
Section 335 (2) stated that:
(a) The balance sheet shall give a true and fair view of the state of affair of the company as at the end of the financial year and
(b) The profit and loss shall give a true and fair view of the profit or loss of the company for the financial year.
A company’s individual accounts shall comply with the provision of schedule 2 as to the form and content of the balance sheet and profit and loss account and additional information to be provided in a way of notes to the account.
Where compliance with the provision of that schedule and other provision of this Act as to the matters to be included in a company individual account or in note to those accounts would not be sufficient to give a true and fair view, the necessary additional information shall be given in the account or in a note to them. See section 335(8). If in special circumstance, compliance with any of those provision is inconsistent with the requirement to the extent necessary to give true and fair view, the direction shall depart form that provision to the extent necessary to give a true and fair view:
Section 335(9) also state “that particular of any such departure the reason for it and its effect shall be given in a note to the account”
Section 360(1):
“Auditor are given a corresponding duty to report on this requirement, stating whether in their opinion the account have been property prepared in accordance with the acts and, whether in their opinion a true and fair view is given”
FINANCIAL STATEMENT AND THE UNDERLYING ASSUMPTION
In order to meet the objective of the financial statement there are some underlying assumption in the basis of its preparation they include accrual basis and going concern.
According to Alexander and Britton (2000:51, 52) discussed the underlying assumption as follows:
(1) ACCRUAL BASIS: Under this basis, the effects of transaction and other event are recognized when they occur (and not as cash or its equivalent is received or paid) and they are recorded in the accounting records and reported in the financial statement of the period to which they relate financial statement prepared on the accrual basis inform users not only of past transaction involving the payment and receipt of cash but also of obligation to pay cash to be received in the future hence, they provide the type of information about past transaction and other event that is most useful to users in making economic decisions.
(2) GOING CONCERN: The financial statements are normally prepared on the assumption that an enterprise is a going concern and will continue in operation for the foreseeable future. Hence, it is assumed that the enterprise has neither the intention nor the need to liquidate or curtail materially the scale of its operation, if such an intention or need exists, the financial statement may have to be prepared on a different basis and if so, the basis used is disclosed.
FINANCIAL STATEMENT AND EFFECTS OF DIFFERENT ACCOUNTING POLICIES
Accounting policies are defined in financial reporting standard 18 (FRS 18) as:
Those principle, bases, convention, rules and practices applied by an entity that specify how the effects of transaction and other events are to be reflect in its financial statement through:
(1) Recognising
(2) Selecting measurement basis for and
(3) Presenting assets, liabilities, gains, losses and changes to shareholders funds
In order words, accounting policies define the processes whereby transaction and other event are reflected in the financial statement.
Accounting policies are bases on which accounting information is prepared may be different; Example stock, valuation, depreciation historic cost or revealed amount treatment of research and development, good will etc.
The effect of this different accounting policies are the limitations and problem encountered when assessing business status, performance and potential, but interpretation of account since it is highly subjective and requires skilled judgement.
DESCRIPTION OF INVESTMENT DECISION
The most important finance function in the modern times is an efficient allocation of capital. It involves decision to commit the firm fund to the long term assets such decision are of considerable importance to the firm since they tend to determine its value size by influencing its growth profitability and risk.
Pandey (2002: 407) defined investment as the firm decision to invest its current fund most efficiently on the long term assets in anticipation of an expected flow of benefits over a series of years.
The firm investment decision would generally include expansion acquisition, modernization and replacement of the long term assets, sale of a division or business (divestment) is also analyzed as an investment decision.
Investment decision invariably requires funds to be tied up in current assets such as inventories and receivable. Such investment is fixed and current assets in one single activity.
Investment decision requires special attention because:
(a) They influence the firm’s growth in the long-run
(b) They affect the risk of the firm
(c) They involve commitment of large amount of fund
(d) They are irreversible or reversible at substantial cost.
(e) They are among the most difficult decision to make
TOOLS FOR EVALUATION INVESTMENT DECISION
In the interpretation and analysis of financial statement the accountant and business analysts have developed various techniques
According to Woelfel (1980: 48) some majorly used techniques are as follows:
(1) Ratio Analysis
(2) Common size balance sheet and profit and loss statement known as comparative statement
(3) Naira and percentage charge
(4) Capital budgeting
RATIO ANALYSIS: Alexander and Britton (2000:452) ratio analysis is the systematic production of ratio from both internal and external financial reports so as to summarise key relationship and result in order to appraise financial performance.
In addition ratio analysis is a major tool of analysis and interpretation of financial statement. Ratio analysis is used to asses performance and liquidity and forecast the future by extrapolating trends.
COMMON SIZE BALANCE SHEET AND PROFIT AND LOSS STATEMENT
In addition to the ratio, financial analyst also employs a tool known as common size balance sheet and income statement.
To form a common size balance sheet one simply divide each asset and liability item by total assets and the expresses the result as a percentage. The resultant percentage statement can be compared with statement of large or smaller firm or those of the same firm over time. To form common size profit and loss statement one simply divides each item by sales.
NAIRA AND PERCENTAGE
The naira amount of charge from year to year is significant but expressing the change in percentage term adds perspective.
The naira amount for any change is the difference between the amount for a comparison year and for a base year. The percentage change is computed by dividing the amount of the charge between years by the amount for the base year.
CAPITAL BUIGETING: CHUKWU (2002: 45) Capital budgeting is the process of preparing plan for the generation, evaluation, selection and following up of capital investment alternatives.
In the same vein capital budgeting can be defined as the decision making process by which firms evaluate the purchase of major fixes asset including building etc. It covers the decision to acquire other firms through purchase of their common stock or group of asset that can be used to conduct an on going business.
According to Pandey (2005: 143) A number of capital budgeting techniques are in use in practices. They may be grouped into the following the categories.
(1) Discounted cash flow (DCF) criteria:
- Net Present Value (NPV)
- Interest Rate of Return (IRR)
- Profitability Index (PI)
(2) Non-discounted cash flow
- Pay back period (PB)
- Discounted Payback Period (DPP)
- Accounting Rate of Return (ARR)
NET PRESENT VALUE: The NPV method is the classic economic method of evaluating the investment proposal. It is a DCF technique that explicitly recognizes the time vale of money. It correctly postulate that cash flow arising at different time period differs in value and are comparable only when their equivalent present value are found out.
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This article was extracted from a Project Research Work/Material Topic “ANALYSIS OF FINANCIAL STATEMENTS FOR INVESTMENT DECISION (A CASE STUDY OF ZENITH BANK PLC)”
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