CHAPTER ONE
1.0 INTRODUCTION
1.1 Background of the Study
The complex nature of today’s business world and the transformation of the entire world into a global village have been of great concerns to manage all forms of business organizations. According to Ojuigo (2001), the problems of managers are multi:-varied because of inefficiency in management of poor decision outcomes of these organizations. Therefore, the managers are unable to achieve the organizational objective within a period of time.
As diverse as business is, its controllable and uncontrollable factors influence all decisions which ultimately lead to the realization of set objectives. To achieve this, management needs reliable, authentic and relevant information from the financial statements to efficiently facilitate decision making.
It must be noted that every business stores at making at least from investments “sustainable profits” so as to stay afloat and continue in business. Therefore, profit being the concern of every manager is a factor in business. To achieve this, available information from the financial statements of organizations must be analysed, interpreted and used as a basis for decision making (Needham and Dransfield 1991). Financial statement analysis is often considered as a vital tool used in evaluating a company’s performance and ensuring that decisions are based on facts rather than rule of thumb.
A financial analyst needs financial statements of companies to be able to identify operating and financial problems which may affect the companies (Mbat, 2001:60). Thus, any person who analyses the financial statements of firms should be able to identify the cause and effect of financial and operating problems of such firms.
The cause of any financial or operating problem is an event, which produces an effect (the problem). However, in order to identify the cause and effect, the system, which represents an indictor f the problem, should be observed. This process is referred to as interpretation (Pandey, 2005). According to (Mbat, 2001), it is the responsibility of the financial manager or analyst to enable them make better management decisions.
The symptoms could be:
- Declining liquidity
- Declining profit
- External debt recovery period
- Increased volume of inventory
- Declining return on total assets
- Increasing operating expenses etc
The identification of causes should also be important in order to appropriately evolve corrective measures.
Financial analysis and interpretation assist in the:
- Identification of organizational performance through the use of analystical data.
- Identification of empirical relationships between operating results and those items which have influenced the achievement of the results.
- Identification of historical data order to determine which internal or external factors have exerted positive or negative influence on the operating results (Mbat 2001).
Categorically, there are three forms of financial analysis. These include: multivariate, univariate and ratio analysis (Welsh, 2007). Moreover, ratios are the end results of basis analysis. The ratio requires an interpretation on the basis of their trends and in the lights of what is known of the business as a young concern. It should be noted that financial statements represent the positions of a firm at a particular point in time.
However, the success or failure of a business depends largely on the quality of decisions made by management, which in turn depends on reality of accounting information available on them. Research into this area is quite relevant given the apparent investment failures experienced by many business organizations. The collapse of many business either private or public is due to poor decision. The question is whether management has used information provided in the financial statement extensively to enable rational decision making?
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