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THE USEFULNESS OF FINANCIAL STATEMENTS IN ASSESSING THE PERFORMANCE OF COMPANIES AND IN GUIDING INVESTMENT DECISIONS

CHAPTER ONE

INTRODUCTION

1.1    BACKGROUND OF THE STUDY

A company’s financial statements are analyzed internally by management and externally by investors and creditors. Management analysis of financial statements primarily relates to parts of the company which enables management to plan, evaluate, and control operation within the company.  Investors and creditors generally focus their analysis of financial statements on the company as a whole, which helps them decide whether to invest in or extend credit to the company.

As a minimum, financial statement will include a statement of source and application of funds.  Having been able to obtain a fair knowledge of the legal aspects of preparing financial statements and having worked examples through basic financial statements of a company, it is reasonable to begin to think of the significance of the futures therein. His is because except the figure in financial statements will not in itself serve any purpose, the figures in the financial statements are therefore:

(a)  How well or badly the company is performing.

(b)  How financially strong or otherwise the company is.

(c)  How valuable or otherwise the company is in terms of its assets base.

Unless a means is available for being able to obtain the information specified above a financial statement would just be of no substance and use. In order therefore to interpret financial statements for the proper information of users, there is the need to proper ratio analysis and when to present to management, a number of issues must be considered.

These include:

(a)  Profitability of the business, operations, particularly in relation to capital employed.

(b)  Solvency of the firm:  The ability of the business to pay its creditors the adequacy of its working capital and the liquidity of its current assets viewed side by side with the current liabilities.

(c)  The business trend:  An analysis of the pattern of business overtime to determine whether profits are rising or falling and the implications for future performance.

(d)  The gearing and cover:  Assessing the adequacy of profits to meet interest payments, pay dividends to shareholders’ investment.

1.2   STATEMENT OF THE PROBLEM

This research work intends to look into the extent to which investors do carry out and rely on the results of financial statements analysis before making their investment decisions, and the employment by companies of financial statement analysis in assessing their performance and that of their respective management.

1.3   OBJECTIVES OF THE STUDY

The objectives of this study are as follows:

(a)  Financial statement analysis consists of applying analytical tools and techniques to financial statements and other relevant data to obtain useful information.

(b)  This information is shown as significant relationships between data and trends in those data that assess the company’s past performance and current financial position.

(c)  The information shows the results or consequences of prior management decisions.

(d)  In addition, the information is used to make predictions that may have a direct effect on decisions made by users of financial statement.

Present company investors and potential company investors are interested in the future ability of a company to earn profits – its profitability.

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