Appraise the effectiveness of financial ratios as a tool for measuring financial performance

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CHAPTER ONE
1.1 INTRODUCTION
An important feature of a typical business organization is the separation of ownership from management, for instance, a limited liability company, it is therefore expedient for management to render stewardship accounts to the owners of the business organization for evaluating the performance of the organization as whole.
THE ORGANIZATIONS AS A WHOLE
The stewardship accounting, which is usually, called the financial reports: contain information that would aid users of such reports in their judgments or decisions about economic and financial matters, especially of the organization concerned. The information is expressed monetary terms.
When the absolute naira amount of most data items reported in the financial statements are considered individually, they are generally of limited usefulness. Significant relationship may not be apparent from a view point of absolute naira amount because no indication is given of whether a particular item is good or bad for the firm. In order to appreciate the users of the report frequently convert significant charges and relationship, the naira amount reported in the financial statement into percentages and ratios by the users of the report.
Therefore, a ratio is a measure used to describe the relationship between two figures which can be expressed as a percentage or a rate in quotient. Taken in isolation, a ratio is meaningless unless it is compared with other ratios and only
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then can draw some meaningful relationship arising from the picture presented by the rates.
Ratio analysis is therefore, described as the relationship between two or more financial data in the financial statement to aid the determination of the financial condition and performance of a firm. It is the interpretation of the balance sheet and income statement of a business organization.
It involves comparing of series of selected items with another series and relating the resultant figures (termed ratios) against standards.
Lucey (2008) defined ratio analysis as the systematic production of ratios from both internal and external financial report to summarize core relationship and outcomes for evaluating financial performance.
A number of ratios are computed to provide useful information to various interest groups having a stake in the organization. Baker (2006) observed that financial ratios assist in conducting spot check on the financial health of an organization. Diagnostically, ratios are used in combination so that a satisfactory outcome for one test is not sufficient to guarantee that all others will yield the same result. Accordingly, it is necessary to work systematically through a series of test before a clean bill of health can be issued.
Financial ratios, though mostly report on past performance, they can be predictive and provide indications of potentials problems areas. The effectiveness of financial ratios as a tool will always determine the quality of decisions made by managers and other users of financial information.
1.2 PROBLEM ANALYSIS
A number of obstacles constitute the research problem. In ratio analysis, the problems faced by company in measuring its financial performance were as follows:
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1. The management of the company is always faced with the problem of identifying the appropriate ratios to use in order to measure the performance growth of the company over a number of years. 2. Another prominent financial related problem is the poor financial management, which continues to affect the ability to which a firm meets its short terms maturing obligations. Business organizations in Nigeria are always faced with the challenges of managing the finance (provided by the owners of the firms) efficiently. This problem of poor financial management had caused havoc in the past, how will managers detect this problem before it escalates and what are the possible solutions to such problems?

3. Banks and non – banks financial institutions are always faced with the need to extend credit facilities to viable client and to finance a project that is worthwhile. How can they fix precisely which client is viable enough to meet their demand or terms) however, to what extent can financial ratios be used as a tool that will assist financial institution in optimizing its objectives? 4. Lastly, investors generally are faced with the problems of investing divesting or increasing their interest in a firm. Individuals and corporate investors ask question like: where should I invest? How many years will it take me to recoup my capital or initial outlay? How profitable is the investment?
1.3 OBJECTIVES OF STUDY
In as much as a research needs to be carried out to appraise the effectiveness of financial ratios as a tool for measuring financial performance, the objective of the study needs to be spelt out. The objective of this study includes the following:
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1. To ascertain how conversant or acquainted managers in business organizations are with financial ratios as a tool for measuring performance. Do managers know what financial ratios really are? Or is it that managers are not even aware that there is a tool like that for measuring performance? 2. To identify the extent to which ratio analysis is of relevance in determining the efficiency and profitable of an organization. 3. To understand the relative importance of ratio analysis in the financing and investing decision of a business organization. This is essential in order to know the effectiveness of the organizations credit and financing policies. 4. To ascertain the importance of ratio analysis to external users in developing confidence in an organization.
1.4 RESEARCH QUESTIONS
In order to achieve the goal for which this study is intended, the following are the underlying research, which are examined:
a. Do top- level managers have a deep understanding of what financial ratio really is? b. Who are the users of financial analysis in an organization? c. Does ratio analysis help an organization to spot its weakness and strength relative to other organization within the industry? d. Does analysis influence the financial and investing decision of an organization? e. Do financial ratios indicate the performance growth of an organization over number years?
1.5 SIGNIFICANCE OF STUDY
This research study will however contribute to knowledge in the following dimensions:
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It will serve as a tool for the analysis of company’s financial statements to determine how well or poorly the business organization or company has performed over the period in question. The study will give companies and other users of financial information the opportunity to assess the impact of various financial data and the process of determining and evaluating ratios.
It could as well as indication of company’s activities such as the ratio between the company’s current assets, current liabilities or between its account receivable and its annual sales.
It will also assist management to understand how suppliers, customers, competitors and other users perceive the company in terms of it performance.
1.6 LIMITATIONS OF STUDY
This study is not attempting you determining how the overall performance of a firm is evaluated, rather, it is concerned with is financial performance and conditions.
Ratio analysis is limited to the analysis of financial information provided in the financial statement published in the last three years. In addition, the research devices into the measuring of financial ratio with the different type.
The term business organization will be limited to Nestle Plc as a case study. Restriction would be placed on where the primary data would be sourced.
In other words, primary data will be sourced mainly from nestle Nigeria plc. In addition certain areas such as the qualitative issues will not be treated in department due to time constraint and other social and economic constraints.
1.7 RESEARCH HYPOTHESIS
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According to Goode and Halt (2002), an hypothesis is what is being looked for in research provided for confirmation by the respondents. They contain independent and dependent variables that shows relationship between them.
For the purpose of this study, the following hypotheses were adopted:
Ho: Ho is the Null hypothesis
Hi: is the alternative hypothesis
Null hypothesis (Ho) is the statement of primary interest (Askia, 1991). This hypothesis is usually put in negative language and it is usually designated (Ho). Alternative hypothesis on the other hand is alternative to the null hypothesis and is designated as (Hi). Putting in mind the research questions the following are the null hypothesis and alterative hypothesis to be tested.
1. Ho: Top level and middle level mangers do not have a deep understanding of what financial ratio analysis is? Hi: Top level and middle level managers have a deep understanding of what financial ration analysis is. 2. Ho: Ratio analysis does not have significant relationship to the weaknesses and strengths of an organization. Hi: Ratio analysis has significant relationship to the weaknesses and strengths of an organization. 3. Ho: Ratio analysis does not influence the financing and investing decision of organizations. Hi: Ratio analysis influence the financing and investing decisions of organizations. 4. Ho: financial ratios do not indicate the performance growth of an organization over a number of years. Hi: financial ratio indicates the performance growth of an organization over a number of years.
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1.8 DEFINITIONS OF UNFAMILIAR TERMS/ CONCEPTS:
The following terms used in this study:
a. Financial analysis: These are the processes of determining the financial performance and financial condition of a firm. b. Financial condition: This term refers to the degree of efficiency in which a firm carries out its financial function. c. Financial performance: this term refers to the degree of efficiency in which aids the evaluations of financial condition and performance. d. Financial ratio: This is the relationship between financial data or figures in the financial statement or record, which aids the evaluation of financial condition and performance. e. Balance sheet: This is the statement of the financial position or the state of affairs of a business at a particular moment or time. f. Assets: These are the economic resources measured in monetary terms, which are possessed by a firm. g. Creditors: these are external claims on the resources (assets) of a firm. They provide external sources of finance to the business organization in the form of loans, bank over drafts trade credit etc. h. Capital structure: This refers to the proportionate relationship between the various long term forms of financing such as debenture, long term debt, reference share capital, equity including reserves and surplus. i. Debentures: These are long term loans granted to a company that are either secured by a specific property or general property or the company i.e. fixed or floating charge. j. Equity: This refer to the network of a business consisting of ordinary share capital, share premium, reserves and surplus. It does not include preference share capital. k. Dividend: This is the portion of firms paid out to the shareholders.
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l. Liquidity: This refers to the ability of a firm to meet its short term obligation as at when due. m. Profitability: This is defined as the ability of a firm to earn surpluses or positive return. n. Insolvency: this refers to the inability of a firm to meet its financial obligation as at when due. o. Present investor: These are individuals or groups of individuals who have already invested in a firm or people who already have a stares in a company. p. Potential invetsors: these are individuals or group of individuals who are planning to invest in a firm.