An Empirical Study Into The Use Of Financial Ratios As A Predictor Of Business Failure (A Case Study Of Selected SMEs In FCT Abuja)

Project and Seminar Material for Accountancy / Accounting

An Empirical Study Into The Use Of Financial Ratios As A Predictor Of Business Failure (A Case Study Of Selected SMEs In FCT Abuja)


Chapter One


Introduction

1.1 Background Of The Study

A financial ratio is a relative magnitude of two selected numerical values obtained from the financial statements of a firm. They are used to determine the overall financial condition of the organization. Weston, J., (1990). Financial ratios are used by current and potential shareholders of a firm, as well as the firm’s creditors. The results from the analysis of financial ratios are used to appraise the firms’ strengths and weaknesses. Financial ratios are calculated using values obtained from the balance sheet, income statement, statement of cash flows. The Financial ratios are used to explain the performances of the various aspect of the business of the firm so as to determine the true position of the firm. This analysis enables the financial analyst to advice the management of the firm on appropriate policies and to be able to predict the profitability or otherwise the firms failure. The understanding attributed to Business failure refers it as the condition in which the firm ceases from operations as a result of the inability to make a profit or generate sufficient revenue to meet and exceed its expenditures. Ames, Michael (1983). The study seeks to proffer an empirical study into the use of financial ratios as a predictor of business failure. A case study of selected SMES in FCT Abuja.


1.2 Statement Of The Problem

The rate of Business failure has been on an alarming rate. This condition is mostly evidenced among small and medium scale business. Therefore, the need for a proper analysis is essential for the determination of the true state of a business so as to forestall the event of failure. Many firms lack the capacity to apply financial ratio analysis due to lack of funds to engage the services of professional accountants. However, it is essential that the financial statement of the firm be subjected to financial ratio analysis to determine the true position of the firm.

Consequently, the problem confronting the study is to proffer an empirical study into the use of financial ratios as a predictor of business failure. A case study of selected SMES in FCT Abuja.


1.3 Objectives Of The Study

The Main Objective of the study is to proffer an empirical study into the use of financial ratios as a predictor of business failure. A case study of selected SMES in FCT Abuja;

The specific objectives include:

  1. To assess the relevance of financial ratios on business organizations.
  2. To determine what are the various financial ratios used in small scale businesses.
  3. To establish what ratios are the significant predictors of business failure.

1.4 Research Questions

  1. What is the relevance of financial ratios on business organizations?
  2. What are the various financial ratios used in small scale businesses?
  3. What ratios are the significant predictors of business failure?

1.5 Statement Of The Hypothesis

Ho1: There is no significant effect of financial ratios as predictor of business failure.


1.6 Significance Of The Study

The study proffers proffer an empirical study into the use of financial ratios as a predictor of business failure. A case study of selected SMES in FCT Abuja. It provides relevant data for the effective formulation and implementation of policies to enhance the realization of envisaged objective.


1.7 Scope Of The Study

The study proffers an empirical study into the use of financial ratios as a predictor of business failure. A case study of selected SMES in FCT Abuja.


1.8 Limitation Of The Study

The study was confronted with logistics and geographical factors.


1.9 Definition Of Terms

Profitability Ratio Defined

Profitability ratio is used to determine the firm’s ability to utilize its assets and management of the firm’s expenses to obtain an acceptable rate of return.

Operating Income

Operating income is the operating profit of the firm which the excess resulting from the difference between operating income and operating expenses.

Liquidity Defined

Liquidity is used to determine the ability of the firm to meet its short term obligation.

Activity Ratio

The Activity ratios determine how effective the firm has deployed its resources.

Business Failure Defined

Business failure refers it as the condition in which the firm ceases from operations as a result of the inability to make a profit or generate sufficient revenue to meet and exceed its expenditures.


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