Statistics

# Analysis of Financial Statements as an Aid to Meaningful Investment Decision Making

## 1.0 INTRODUCTION

Decision making is not the core of every investment activity. A decision is a choice between two or more alternatives. The implementation of meaningful decision gives way for achievement of investment goals and objectives while implementation of wrong decision positively give rise to investment failure. The ultimate objectives for investment are profit maximization and growth thus it becomes necessary that capital decision have to be made and implemented so as to achieve the aforementioned objectives. For a meaningful decision that will be used in these objective for an investment to be made available, analysed and studied and through what is derived, decision is made and implemented wither for action, execution or corrective measures where necessary. One of the important information needed about investment is concerned with financial aspect and the record that contains the financial aspect of an investment is what is referred to as analysis of financial statement referred to as analysis of financial statement analysis. According to financial statement analysis and interpretation for alert investors by C. Chinelo Ikoku, financial statement components are as follows:

1. The chairman board of directors report

2. The auditor’s report

3. Graphs and figures.

4. Table of accounting date. Financial analysis via ratios hence it is sometimes referred to as ratio analysis or accounting ratios analysis interpreting investigation into financial statement. The ratios derived from financial statements are used in three different ways namely:

1. Structural analysis

2. Time series analysis

3. Cross sectional analysis. For investment executions, decision such as buy, certain or sell are necessary. Equally, decision for evaluating management performance, as well as current and future level of risk and profitability is all important. Meaningful decision in all the above mentioned areas will help for a good choice among available portfolio of assets, dividend yield, total return as well as liquidity. In this project study, concentration will be based on such financial ratio as:

a. Profitability ratio

b. Liquidity ratio

c. Asset management ratio

d. Market value ratio

## 1.1 STATEMENT OF THE RESEARCH PROBLEMS

Many investors are know to have entered into investment ventures without property understanding such investment opportunity, thus making and implementing wrong decision thereby ending up in folding up when the going proved impossible. At times when the investment activities go on, the aim for such action not realized. Investment failures have equally been identified with poor management, which arises as a result of mobility of the management of such investment firms in making meaningful decisions required for such investment opportunity. Many investment are carried out without emphasis laid on those investments that would generate profitable returns in the future, the risk involved and the benefits to be derived if embarked upon given the scarce financial resources and the resultant effect of failure. Such set back is the life of an investor and in the case of investment firms, liquidation.

All the above stated problem arises as a result of wrong decision making hence, this study will therefore, identify the means through which meaningful decision can be derived as to enhances the changes available for investment entities or firms through analyzing information concerning such investment opportunities.

## 1.2 PURPOSE OF THE STUDY

Investment failures have been identified with poor managerial and investors decision approach, which arises as a result of poor knowledge about an investment as to help in making meaningful decisions for investment purpose and realization of goals. This study intends to find out the following:

1. How analysis of financial statement can help in making meaningful decision, which will enhance investment structure and goal realization.

2. To ascertain the different decision bench marks employed by investment.

3. To demonstrate the interpretation of computed ratios.

Investment failure has been so pronounced in the recent times. In the process, capitals are lost and set backs experienced as a result of low return to stockholders and in some cases complete liquidation. In this study therefore, the researcher intends to find out how analysis of financial statements will aid in making meaningful decision that will enhance investment chances in realizing objectives to convert loss of capita and set backs experiences or total liquidation.

## 1.3 RESEARCH QUESTIONS

The dimension that this research will cover will be based on the following questions, which will help in increasing an insight into the problems under investigation.

1. To investment failure arise from implementing wrong decision?

2. Does poor decision implementation cripple investment grail actualization?

3. Are decision derived from analyzing financial statements?

4. Does poor management arise from inability to evaluate or analyzed investment opportunities?

5. To what extent are decisions derived from financial statement relied?

6. To what extent is decision derived from analysis of financial statement used?

7. How does investment firms make their decision?

8. Do investment proposals require analysis or evaluation to be made on them?

## 1.4 STATEMENT OF HYPOTHESIS

1. HO: Using analysis of statement while making investment decision will not vary significantly with the probability of the investment.

Hi: Using analysis of statement white making investment decision will vary significantly with the probability of the investment.

2. HO: There is no significant relationship between investment decision and analysis of financial statements.

Hi: There is significant relationship between investment decision and analysis of financial statements.

3. HO: There is no significant relationship between investment decision and investment profitability.

Hi: There is significant relationship between investment decision and investment profitability

## 1.5 SIGNIFICANCE OF THE STUDY

It is hope of the researcher that the findings and recommendations of this project work will be of great importance to many interested persons. The significance of the study will include the following.

a. It will serve useful purpose to investors, the importance of making meaningful investment decisions through analyzing financial statement of an investment at any point in time.

b. To create in investors the awareness of the risk associated with a particular investment as it can be revealed through analysis of financial statements of such investment thus ceiling for proper decision making.

c. Expose investors to the benefit derived in making meaningful decision among alternatives that will be of goal outcome for an investment.

d. To expose investors to awareness on how the setbacks and bitter experienced witnessed from investment failure can be totally eradicated through implementation of meaningful decision.

## 1.6 SCOPE AND LIMITATION OF STUDY

This research work will be conducted among selected investment firms in Enugu state. The localization of the study is informed by the financial constraints on the part of the researcher. The study has also been subjected to time constants because it was carried out single handedly by the researcher. Bureaucracy as practiced by the firms and dearth of relevant information constituted impediment and limitations in themselves.

## 1.7 OPERATIONAL DEFINITION OF TERMS

To enhance a proper understanding of this research work, the following technical terms have been defined.

### DECISION MAKING

There is a deliberate thought process that leads to the taking of action. Decision making is used essential in execution of both long and short term plans. Relevant information for decision making must be expressed in forms of financial or quantitative analysis in order that a rational choice can be made.

### FINANCIAL STATEMENT

This is records that contains financial reports of an investment or business entity.

### FINANCIAL RATIO

It is ratio that can be calculated form an investment financial statements which enhance our understanding financial statements which enhance our understanding of investment financial performance and position.

### LIQUIDITY RATIOS

They measure the ability of the firm to meet its obligations as they become due. The liquidity ratios by establishing a relationship between cash and other current assets to current obligations provide a quick measure of liquidity. An excess liquidity will result in bad credit raking and loss of confidence by creditors.

### CURRENT RATIO

This is computed by dividing current assets by current liabilities current assets include cash marketable securities, accounts receivables and inventories. Current liability consist of accounts payable, notes payable, accrued income and taxes short-term loans etc.

### LEVERAGE RATIOS

Leverage ratios measure the funds supplied by the owners of the business as compared to the finance provided by the firm’s creditors. As a general rule, there should be an appropriate mix of debt and equity in financing the firm’s assets. From the creditor’s point of view, a higher incidence of owner financing is desirable because investors look to firms equity stock for security in the event of liquidation. On the part of the owners of the firm, a higher incidence of creditor financing is desirable. If borrowed funds can be used by the business to generate earnings in excess of interest charges on those funds, then borrowing has benefited the owners.

Leverage is approached in two ways. One approach examines balance sheet ratios and determines the extent to which borrowed funds have been used to finance the firm. The other measures the risk of debt by income statement ratios designed to determine the number of time fixed charges are covered by operating profits. Firms with low leverage ratios have less risk of loss when the economy is in a downturn, but they have lower expected returns when the economy booms. Conversely, firms with high leverage ratios run the risk of large losses but also have a chance gaining high profit.

### TOTAL DEBT TO TOTAL EQUITY

This is a measure of the relative claims of creditors and owners against the firms assets. The ratio considers both current liabilities and non current liabilities in the numerator. The stake of the owners in the business vis-à-vis that of creditors must take control of the business with high sense of responsibility.

### TIME INTEREST EARNED RATIO

It measures the degree to which earnings can decline without resultant financial problem to the firm because of its inability to meet interest cost.

### ACTIVITY RATIOS

These ratios are employed to evaluate the efficiency with which the firm manages and utilizes its assts. The activity ratios involve a relationship between sales and various assets. A proper balance between sales and assets generally reflects that assets are managed very efficiently.

### TOTAL ASSETS TURNOVER

It measures the capacity with which total assets are utilized to generate the firms turnover. It is calculated by dividing sales by total assets.

### CAPITAL EMPLOYED TURNOVER

The capital employed is the permanent or long run funds entrusted to the firm by the creditors and owners.

### PROFITABILITY RATIO

These ratios examine how effectively the firm is being managed. The managers, creditors, shareholders, as well as the employees of the firm are interested in the profits of the firm. It assess the economic condition of an investment. It shows profitability in relation to investment . they indicate efficiency of operation.

### GROSS PROFIT MARGIN

This margin is used to evaluate the spread between sales revenue and the cost of goods sold. It is computed by diving gross profit by turnover.

### NET PROFIT MARGIN

The ratio measures the management efficiency in the administration of the business. It is used to determines the return on per Naira of sales.

### RETURN ON CAPITAL EMPLOYED

It measures how well the management has utilized funds supplied by the shareholders and creditors.

### RETURNS ON TOTAL ASSETS

It measures the rate of efficiency with which the firm has employed its assets for purposes of making profit.

### EARNING PAYOUT RATIO

This is the ratio that represents the position of investment earnings that is paid as dividend to shareholders.

### EARNING YIELD

This is measurement of return on investment.

### INVESTMENT FIRMS

These are firms associated with commitment of resource for gains actualization.

### RETURN ON INVESTMENT

This measures the efficiency with which an investment has utilize the total fund available in generating profit.

### WORKING CAPITAL

Working capital refers to a firm’s investment in short-term assets-cash, marketable securities, trade debtors and stock, less current liabilities used to finance the current assets. Working capital management therefore means the planning and controlling of both current assets and current liabilities. It involves the administration of cash, receivables, inventories marketable securities and the current liabilities.