Uses Of Accounting Ratios In Business Decisions

Project and Seminar Material for Business Administration and Management BAM

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:

  1. The ability of the business to pay its way and survive in the long run.
  2. The quality of management and the rightness of decision made.
  3. 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:

  1. Do accounting ratio confuse financial statement users and increase their tendency of becoming victims of inadequate business decisions?
  2. Is ignorance of importance of accounting ratio responsible for defective business decisions by users of financial statements?
  3. Are negligence and disregard of ratio analysis responsible for wrong business decisions by users of financial statement?
  4. Do financial statements contain differences and trouble that misdirect their users?
  5. Do users of these statements require more enlightenment campaigns and workshops to enable them comprehend their importance?
  6. 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:

  1. Time: The researcher moved form place to place and time was not on his or her side to reach all the information she required.
  2. Finance: Being a student, the researcher did not have the required cash outlay for data collection and stationary procurement.
  3. Insufficient information: Some officials believe that their financial documents and information is not for external use.
  4. Changes in price level make the analysis invalid: There are decreases and increases in result of fall and rise in the prices.
  5. The ratios at a point in time is meaningless unless when compared with another.
  6. The ratios are calculated on account of historical (past) financial statements and are not good indicators of the future.
  7. The differences in situations of two firms or one firm over a period of time make comparison cumbersome.
  8. Differences that abound on definitions of terms in the balance sheet and profit and loss account make interpretations difficult.

Uses Of Accounting Ratios In Business Decisions


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Uses Of Accounting Ratios In Business Decisions


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Frequently Asked Questions


What is the importance of accounting ratio?

Accounting ratio is the most important factor used by management, creditors, investors and other users of financial statement in carrying out most business decisions.

Do accounting ratios confuse users of financial statements?

(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.

What are the uses of financial ratio analysis?

Uses of Financial Ratio Analysis Financial ratio analysis helps a business in a number of ways. The importance and advantages of financial ratios are given below: (i) Ratios help in analyzing the performance trends over a long period of time.

Why ration analysis in business decision making?

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.

Why are financial ratios important?

Financial ratios are important tools for quantitative analysis. Certain ratios are available to evaluate both short- and long-term financial and operational performance, making them useful at identifying trends in the business and providing warning signs when it may be time to make a change.

What is the importance of accounting ratio?

Accounting ratio is the most important factor used by management, creditors, investors and other users of financial statement in carrying out most business decisions.

What are the limitations of accounting ratios?

Accounting ratios are based on accounting figures given in the financial statements. However, accounting figures are themselves subject to deficiencies, approximations, diversity in practice or even manipulation to some extent. Therefore, ratios are not very helpful in drawing reliable conclusions. 2.

What is ratio analysis of financial statements?

While ratio analysis of financial statements is theoretically as simple as collecting the necessary documents and performing basic calculations, investing in a cloud-based, centralized data management solution like Planergy is a smart move for any business interested in making optimal use of financial ratio analysis.

What are the most common ratios in financial statements?

We will highlight some of the more common ratios in the table below that you may use as a handy reference: 1. Debt-to-Equity Ratio = Liabilities (Total) / Shareholder Equity (Total) 2. Debt Ratio = Total Liabilities/Total Assets 1. Current Ratio = Current Assets/Current Liabilities 2.

What is the formula for financial ratios?

The financial ratios formulas table shows the formula for the financial ratio together with its category and a brief explanation. Purchases: Purchases of goods and services = COGS + Change inventory + Overheads * With balance sheet items it is best to use an average value of the opening and closing balances if available.

What is the significance of ratio analysis?

Significance of Ratio Analysis as Tool of Financial Analysis: Ratios are exceptionally useful tools with which one can judge financial performance of the enterprise over a period of time. The efficiency of the enterprise can also be judged against the industry average.

What is ratio analysis and how do you do it?

What Is Ratio Analysis? Ratio analysis is a quantitative method of gaining insight into a company’s liquidity, operational efficiency, and profitability by studying its financial statements such as the balance sheet and income statement. Ratio analysis is a cornerstone of fundamental equity analysis .

What is the importance and advantages of financial ratio analysis?

Financial ratio analysis helps a business in a number of ways. The importance and advantages of financial ratios are given below: (i) Ratios help in analyzing the performance trends over a long period of time.

How can ratios be used to analyze the degree of efficiency?

Certain ratios help us to analyze the degree of efficiency of the firms. Ratios like account receivables turnover, fixed asset turnover, and inventory turnover ratio. These ratios can be compared with the other peers of the same industry and will help to analyze which firms are better managed as compared to the others.

Why is it important to understand stock and company ratios?

Likewise, they measure a company today against its historical numbers. In most cases, it is also important to understand the variables driving ratios as management has the flexibility to, at times, alter its strategy to make its stock and company ratios more attractive. 

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