A Critical Analysis Of The Use Of Accounting Ratios To Measure Financial Performance Of An Organization

A Critical Analysis Of The Use Of Accounting Ratios To Measure Financial Performance Of An Organization

Abstract

This study was carried out to critically analyze the use of accounting ratios to measure financial performance of an organization using Nigeria Breweries Plc, Lagos State as a case study. The study was set to identify the different forms of ratio used by Nigeria Breweries Plc, determine the role of accounting ratio analysis in measuring financial performance of Nigeria Breweries Plc and identify the limitations of ratio analysis in measuring performance of Nigeria Breweries Plc. The survey design was adopted and the simple random sampling techniques were employed in this study. The population size comprise of staff in the finance/accounting department Nigeria Breweries Plc, Lagos State. In determining the sample size, the researcher conveniently selected 65 respondents and only 50 were validated. Self-constructed and validated questionnaire was used for data collection. The collected and validated questionnaires were analyzed using mean scores. While the hypotheses was tested using Chi-square statistical tool. The result of the findings reveals that the different forms of ratio used by Nigeria Breweries Plc includes: profitability ratios, liquidity ratios, debt ratios, performance ratios and investment evaluation ratios. The findings further show that the role of accounting ratio analysis in measuring financial performance of Nigeria Breweries Plc includes: it is used by the organization to analyze financial statements, it helps in locating weakness, it is used in formulating plans, it is used by organization especially when judging efficiency. Therefore, it is recommended that the organization should enhance good recruitment procedures to enable analysis of ratios and as well overcome challenges related to incidents like false accounting data which gives false ratios. To mention but a few.

Table of Content

• Title Page
• Certification
• Dedication
• Acknowledgement
• Table of Content
• List of Tables
• Abstract

Chapter One:

Introduction

• 1.1 Background of the Study
• 1.2 Statement of the Problem
• 1.3 Objective of the Study
• 1.4 Research Questions
• 1.5 Research Hypothesis
• 1.6 Significance of the Study
• 1.7 Scope of the Study
• 1.8 Limitation of the Study
• 1.9 Definition of Terms
• 1.10 Organisations of the Study

Chapter Two:

Review of Literature

• 2.1 Conceptual Framework
• 2.2 Theoretical Framework
• 2.3 Empirical Review

Chapter Three:

Research Methodology

• 3.1 Research Design
• 3.2 Population of the Study
• 3.3 Sample Size Determination
• 3.4 Sample Size Selection Technique and Procedure
• 3.5 Research Instrument and Administration
• 3.6 Method of Data Collection
• 3.7 Method of Data Analysis
• 3.8 Validity of the Study
• 3.9 Reliability of the Study
• 3.10 Ethical Consideration

Chapter Four:

Data Presentation and Analysis

• 4.1 Data Presentation
• 4.2 Analysis of Data
• 4.3 Answering Research Questions
• 4.4 Test of Hypotheses

Chapter Five:

Summary, Conclusion and Recommendation

• 5.1 Summary
• 5.2 Conclusion
• 5.3 Recommendation
• References
• APPENDIX
• QUESTIONNAIRE

Chapter One

Introduction

1.1 Background of the Study

To Altman (2008), in countries where financial instability is rife and financial intuitions are becoming popular, when it comes to investing, the sound analysis of financial statements is one of the most important elements in the fundamental analysis process. At the same time, the massive amount of numbers in a company’s financial statement can be bewildering and intimidating to many investors, creditors and those who are concern with the financial statement.

Beaver, W. (2017), asserts that financial ratios serve a similar purpose, but you must know what is being measured to construct a ratio and to understand the significance of the resulting number” (Stanly 1994).The statement used for accounting ratio analysis is the annual financial report of a firm which consists of three financial statements; the balance sheet, income statement and cash flow statement. The analysis conducted in each of this statement provides the vital information required regarding the financial performance of the firm for making sound investment decisions. Analysts therefore depend on the use of the financial statements to provide the data needed to update accounting ratios. According to Igben (2013), “Accounting {or financial} ratio consist of the fraction, proportion or percentage which compare the relationship between one variable item in a set financial statements with another item in the financial statements. Consequently Accounting ratios are vital for the analysis and interpretation of financial statements”. Block (2009) defines accounting as the process of systematically recording, measuring, and communicating information about financial transactions. At the heart of accounting is the double-entry bookkeeping method. This involves making at least two recording entries for every transaction: a debit in one account and a credit in another account. The method helps prevent errors because the sum of the debits should equal the sum of the credits. The three major financial statements produced by accounting are the income statement, the balance sheet and the cash flow statement.

Bondoc M, 2013 defines accounting as the systematic and comprehensive recording of financial transactions pertaining to a business. Accounting also refers to the process of summarizing, analyzing and reporting these transactions to oversight agencies, regulators and tax collection entities. The financial statements that summarize a large company’s operations, financial position and cash flows over a particular period are a concise summary of hundreds of thousands of financial transactions it may have entered into over this period. To Brigham, 2008, accounting ratios are indicators of a commercial entity’s performance and financial situation. We calculate the majority of ratios from data that the firm’s financial statements provide. Accounting ratios, also known as financial ratios, are used to measure the efficiency and profitability of a company based on its financial reports. They provide a way of expressing the relationship between one accounting data point to another, and are the basis of ratio analysis. This was attributed to the fact that an accounting ratio compares two line items in a company’s financial statements, namely made up of its income statement, balance sheet and cash flow statement. These ratios can be used to evaluate a company’s fundamentals and provide information about the performance of the company over the last quarter or fiscal year. Examples of financial ratios include gross margin, operating margin, the debt-to-equity ratio, the quick ratio and the payout ratio Financial performance as argued by Brealey, 2013 is a subjective measure of how well a firm can use assets from its primary mode of business and generate revenues. This term is also used as a general measure of a firm’s overall financial health over a given period of time, and can be used to compare similar firms across the same industry or to compare industries or sectors in aggregation. There are many different ways to measure financial performance, but all measures should be taken in aggregation. Line items such as revenue from operations, operating income or cash flow from operations can be used as well as total unit sales. Furthermore, the analyst or investor may wish to look deeper into financial statements and seek out margin growth rates or any declining debt.

1.2 Statement of the Problem

Many firms, institutions and businesses have knowledge about accounting ratios, analysis and its interpretation. Some businesses make use of these ratios but apply them wrongly, others also use the right method but give wrong interpretations to it and most firms do not apply atall. The need to determine the financial performance of the firm is crucial for making informed decisions concerning the further deployment of resources and investment decisions. This can only be done through accounting ratio analysis. Eventually this is not often an easy task to undertake as many investors and business owners lack the understanding and skill to perform accounting ratio analysis’ Accounting ratios facilitates the determination of the efficiency and profitability of a firm which is fundamental for investment decisions based on the firms financial reports. Accounting ratio facilitate the comparison of two aspects of a financial statement .Some examples of accounting ratios include the dividend ratio, gross margin ratio, debt-to-equity ratio and operating margin ratio. It is because of the above problems that prompted the researcher of this study to write about the use of accounting ratio and its interpretation, Brigham (2015).

1.3 Objectives of the Study

Generally, the purpose of the study is to examine the use of accounting ratios to measure financial performance of an organization. Specifically it seeks to:

1. To identify the different forms of ratio used by Nigeria Breweries Plc.
2. To determine the role of accounting ratio analysis in measuring financial performance of Nigeria Breweries Plc.
3. To identify the limitations of ratio analysis in measuring performance of Nigeria Breweries Plc.

1.4 Research Questions

The following research questions will guide and help the researcher to achieve the specified objective of this study:

1. What are the different forms of ratio used by Nigeria Breweries Plc?
2. What is the role of accounting ratio analysis in measuring financial performance of Nigeria Breweries Plc?
3. What are the limitations of ratio analysis in measuring performance of Nigeria Breweries Plc?

1.5 Research Hypothesis

• Ho: The use of accounting ratios is not effective for measurement of financial performance of an organization.
• Ha: The use of accounting ratios is effective for measurement of financial performance of an organization.

1.6 Significance of the Study

This study gives insight into the various ways or techniques that will help improve organizations performance and how the financial performance of organizations in Nigeria can be properly assessed. The study will also go a long way in showing the various accounting techniques that managers can adopt in measuring financial performances, and its implications on the financial position of organizations.

The findings and recommendations of the researcher will help in building a strong and better accounting practices that will help in the assessment of organizations performance in Nigeria, if taken seriously by government and the general public. It may serve as a reference to other researchers who may want to research into the field.

1.7 Scope of the Study

The study generally focus on assessing analysis of the use of accounting ratios to measure financial performance of an organization. The study will be carried out in Nigeria Breweries Plc, Lagos State. Hence, the entire staff in the finance/accounting department will serve as the respondents for the study.

1.8 Limitations of the Study

Like in every human endeavour, the researchers encountered slight constraints while carrying out the study. The significant constraint was the scanty literature on the subject owing to the nature of the discourse thus the researcher incurred more financial expenses and much time was required in sourcing for the relevant materials, literature, or information and in the process of data collection, which is why the researcher resorted to a limited choice of sample size. Additionally, the researcher will simultaneously engage in this study with other academic work. More so, the choice of the sample size was limited as few respondent were selected to answer the research instrument hence cannot be generalize to other secondary schools. However, despite the constraint encountered during the research, all factors were downplayed in other to give the best and make the research successful.

1.9 Definition of Terms

Accounting:

The process of recording, summarizing, analysis and interpreting financial (money-related) activities to permit individuals and organizations to make informed judgments and decisions.

Financial Ratio:

A proportion, fraction, or percentage expressing the relationship between one item ion sett of financial statements and another item in the same financial statements.

Financial Statement:

Quantitative information on the economic activities of an organization prepared to show the result and the financial position of the entity, often presented in terms of Balance Sheet, Income Statement, Funds flow statement, and so on.

Income Statement:

A financial statement often referred to as the trading and profit loss account, matching revenues against expense to show the profitability or operational results of an enterprise over a period of time, such as a month or year.

1.10 Organization of the Study

The study is categorized into five chapters. The first chapter presents the background of the study, statement of the problem, objective of the study, research questions and hypothesis, the significance of the study, scope/limitations of the study, and definition of terms. The chapter two covers the review of literature with emphasis on conceptual framework, theoretical framework, and empirical review. Likewise, the chapter three which is the research methodology, specifically covers the research design, population of the study, sample size determination, sample size, and selection technique and procedure, research instrument and administration, method of data collection, method of data analysis, validity and reliability of the study, and ethical consideration. The second to last chapter being the chapter four presents the data presentation and analysis, while the last chapter(chapter five) contains the summary, conclusion and recommendation.

Chapter Five

Summary, Conclusions and Recommendations:

5.1 Introduction

This chapter summarizes the findings on a critical analysis of the use of accounting ratios to measure financial performance of an organization using Nigeria Breweries Plc, Lagos State as a case study. The chapter consists of summary of the study, conclusions, and recommendations.

5.2 Summary of the Study

In this study, our focus was ona critical analysis of the use of accounting ratios to measure financial performance of an organization using Nigeria Breweries Plc, Lagos State as a case study.The study was specifically focused on identify the different forms of ratio used by Nigeria Breweries Plc, determine the role of accounting ratio analysis in measuring financial performance of Nigeria Breweries Plc and identify the limitations of ratio analysis in measuring performance of Nigeria Breweries Plc.

The study adopted the survey research design and randomly enrolled participants in the study. A total of 50 responses were validated from the enrolled participants where all respondent are staff in the finance/accounting department Nigeria Breweries Plc, Lagos State.

5.3 Conclusions

In the light of the analysis carried out, the following conclusions were drawn.

1. The different forms of ratio used by Nigeria Breweries Plc includes: profitability ratios, liquidity ratios, debt ratios, performance ratios and investment evaluation ratios.
2. The role of accounting ratio analysis in measuring financial performance of Nigeria Breweries Plc includes: it is used by the organization to analyze financial statements, it helps in locating weakness, it is used in formulating plans, it is used by organization especially when judging efficiency.
3. The limitations of ratio analysis in measuring performance of Nigeria Breweries Plc includes: false accounting data which gives false ratios, it may be misleading in the absence of absolute data for the organization, at times the comparison is not possible if different firmsadopt different accounting policies, ratio analysis becomes less effective due to price levelchanges and lack of proper standards affects the appropriateness ofratio analysis.

5.4 Recommendation

Based on the findings the researcher recommends that;

1. From the findings of the study results depicted that profitability, liquidity, debt ratio among others are the forms of ratio used by the company, however it is recommendable that the organization improves on the debt ratio used by the organization to manage the budgets.
2. The organization needs to provide good proper working conditions for accomplishment of the assigned tasks. This should be backed by enhancement of employee involvement programs and provision of employee training and refresher programs.
3. The organization should enhance good recruitment procedures to enable analysis of ratios and as well overcome challenges related to incidents like false accounting data which gives false ratios.

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