Use Financial Ratios In Management Decision Making (A Case Study Of Transcorp Ltd Enugu Branch)
This project titles “The use of financial Ratios in management decision was written after a careful and through research and receive on financial ratios, the various types and its application in making management decisions.
In recent times, some business failure have been due to wrong analysis and wrong application of financial statement.
To be able to discus this project topic in full and give adequate recommendation a critical review of related literature on the subject was carried out.
The case study was focused on Nigeria telecommunication limited (Transcorp), an analygan of the telecommunication department and the Nigerian External Telecommunications limited (Transcorp).
The study was carried out through the use of survey research method which involved the collection data mainly by the use of questionnaire. The questionnaires which was developed from the research questions (hypothesis) was designed to elect information on the subject matter.
It was complemented with interview and direct observation. Data collection and analysis was done using tables, percentages and statistical charts, testing of hypothesis were done using the chi-square method.
The research finding reviewed that transcorp ltd uses financial ratios in making management decision. It also reviewed that other factors like, government policy, World Bank recommendations, share holders needs, staff needs, company policy and objectives, cost/benefit analysis and so on are also considered in decision making.
On completion of this study, it was recommended among other things, that transcorp ltd should continue to make use of financial ratios in making management decision since the use of it obviously head to improved overall performance in the company’s operation it was also recommended that if the use of financial ratios is expected to yield increased result, government should deficit the ideal of imposing bureaucratic controls on the company’s management.
1.1 BACKGROUND STUDY
“Ration are among the best known and most widely used tools of financial analysis.
A ratio expresses the mathematical relationship between one quantity and another. The ratio to 200 to 100 is expressed as 2:1. While the computation of a ratio involves a simple arithmetical operation, its interpretation if a far more complex matter.
To being with, to be significant the ratio must express a relationship that has significance. Thus, there is a clear, direct and understandable relationship between the sales price of an item on one hand its cost on the other.
As a result, the ratio of cost of goods sold to sales is a significant one. On the other hand, there are no understandable relationships between freight costs incurred and the marketable securities held by an enterprise and hence, a ratio of one to the other must be deemed to be of no significance.
Ratios are tools of analysis which in most cases provides the analysis of with clues and symptoms of underlying conditions. Ratios properly interpreted can also point the way to areas requiring future investigation and inquiring. The analysis of ratio can disclose relationship as well as bases of comparison which reveal conditions and trends that cannot be relieved by any other individual components of the ratio.
Since ratios like other tools analysis are future oriented, the analyst must be able to adjust factors present in a relationship to their probable shape and size in the future. He must also understand the factors which will influence such ratios in the future, thus, in the final analysis; the usefulness of ratios is wholly dependent on their intelligent and skillful interpretation.
This is by far the moot aspect of a ratio analysis. In addition to the internal operating conditions which affect the ratios of an enterprise, the analyst must be aware of the factors, such as general business conditions, industry position, management policies as well as accounting principles, which can affect them, as far as the letter are concerned, the discussion of accounting principles points out their influence on the measurement on which rations are based.
Ratios, like most other relationship in financial analysis are not significant in themselves and can be interpreted only by comparison with (i) past ratios of the same enterprise, or (ii) some predetermined standard or (iii) ratios of other companies in the same industry. The range of a ratio over time is also significant as is the trend of a given ratio over time.
Create many ratios can be developed from the multitude of items included in an enterprise, financial strangest. Some ratios have general application in financial analysis while other have specific uses in certain circumstances or in specific industry.
REF 1 LEOPOLD A’ BERNSTEIN FINANCIAL STATEMENT ANALYSIS THEORY APPLICATION AND INTERPRETATION (PAGE 67 AND 69)
1.2 MEANING OF FINANCIAL RATIO
A ratio is the indicated quotient of two mathematical expressions. In financial position and performance of a firm”2 the relationship between two accounting figures expressed mathematically is known as financial ratio. Ratio assist the financial analysis in making qualitative judgment about the financial perform of the firm.
Ratio analysis itself is a technique of reducing aggregate financial data into meaningful ratios for the purpose of assessing weather the ratio indicates a weakness or strength in the company’s affairs.
Financial ratios in a nutshell are those ratios arrived at by subjecting financial data to analysis trough a technique known as ratio analysis.
1.3 THE CONSTITUENTS OF MANAGEMENT DECISION
The most important of the skills that a manger must have in other to make the right and successful decision is making skills. Present a problem to all levels of manager. Good decisions are the end product of having the required skill, attitude, organizational support and knowledge. Each of these factors is essential to effective decision making. The word management could be define.
As the process of combing and utilizing or organizing directing and controlling an organization for the purpose of producing outputs (goods and services or whatever the objective are) desired by customers so that organization objectives are accomplished.
4 Decision making from among hand is a process of selecting from among at alternative “THERAUF” also defined decisions as a series of steps that starts with an identification of problem to be solved, collection and analysis of pieces of information of relevant to the problem outlay of alternative of the problem and ultimately a resolution, that is a selection from several available alternatives to solve the problem under considerations.
The decision making process by the management of any organization therefore has the following stages at constituents.
- The definition of the problem of be solved.
- Recognition of relevant factors that bear on problems.
- Analysis and evaluation of the effects of the relevant factors.
- Weighting alternative solutions.
- The choice making which innerves judgment.
REFE 2 –JOHN ORJNH 2008 FINANCIAL MANAGEMENT
REF – 3 R.L BOMBLATUS – MANAGEMENT ACCOUNTING (PLTTSBURGH 1959) PAGE 24
Ref 4 – Agwu Akpala An introduction and the Nigeria perspectives management Grpartment of management UNEC, 1990 (page 3)
Ref Agwu Akpala, opp reference No 4 page 5.
1.4 STATEMENT OF PROBLEM
It has been shown that ratio analysis on its own does not always automatically rectify statement nor the only parameter used in management decision making nor as it sufficient for interpreting company’s accounts. The study therefore, is faced with the problem of determining the extent to which financial ratios can assists management of any organization in interpreting the company’s accounts and the extent to which management uses them in the decision making.
1.5 PURPOSE OF STUDY
The purpose of this research study is to carryout analysis of financial ratios of (Transcorp Ltd) from 1989-1993 to determine performance and then compare it with standard set by the world bank for the company, and then determine the extent to which it is used by the management of the company’s decision making.
In carrying out analysis of accounts a number of issues must be considered and conclusive formed there on, which includes:
- Profitability stability of this company.
- Solvency of stability of the company.
- Financial stability of the company
- Analysis of the business set to determine whether profits are rising or falling and the implications for future performance.
- Assessing the adequacy of profit to meet interest payment, pay dividend to shareholders and provide sufficient
- Finally, to final out if these ratios are actually used in management decision, the extent of use and the result of use.
1.6 SIGNIFICANCE OF STUDY
The benefits of an effective application of financial ratios analysis of business organization cannot be overemphasized. This is because, the study when complex and with consequent recommendations will go a long way in assisting the policy makers of various organizations, both the study however, would be of immense benefits to the shareholder of transcorp, government, investors, financial house or institutions, long term and short term creditors, students, the general public at large, Transcorp management boards or team, and to further researchers on the subject who will need the works as a references materials in their research.
1.7 STATEMENT OF HYPOTHESIS
Taking into consideration, the nature and extent of the problem stated so far, the researcher deemed it necessary to formulate the following hypothesis to help her analyse her findings.
- H0: Transcorp Ltd does not use financial ratios in making management decisions.
H1: Transcorp Ltd uses financial ratio in making management decisions.
- H0: All the financial ratios reflected in the financial statement are not used for management decision.
Hi: All the financial ratios reflected in the financial statement are used in making management decision.
- H0: Transcorp Ltd uses other parameters other than financial ratios for making management decision.
H1: Transcorp Ltd does not use other parameter other than financial ratios in making management decision.
- Ho: The use of financial ratios does not make for faster and wiser management decision.
H0: The use of financial ratios does not make for faster and wiser management decision.
H1: The use of financial ratios making for faster and wiser management decision.
Cost of typing and binding of this project would be high intew of the present economic condition in the country.
1.9 BACKGROUND OF THE CASE STUDY COMPANY
The Nigeria telecommunication Plc is a federal government owned company that provided telecommunication service to all Nigerians. It was set up in 1985 and amalgam of the telecommunication united net.
Transcorp ltd. has an estimated number of staff standing at about 2500 workers from data collected at present.
It operates a three-tiers of organization structure to corporate headquarters in Abuja, five zonal offices and 3b territorial administration, a system that alliances decentralization currently, the four zones of transcorp are Lagos zone with headquarters in Lagos, Northwest zone with headquarters in Bauchi, South west zone with headquarters in Enugu. Each state of the federation represent a territorial zones.
Fully commercialized under the privatization and commercialization policy of the federal government of Nigeria.
Transcorp ltd. More than ever is committed to the provision of efficient, reliable and cost effective telecommunications services nationally and international. This set off objectives has remained the guiding principle on based.
On incorporation the company had an authorized share capital of 4,000,000 shares of N1.00 each with N2,000,00 fully paid up by the government. This was reviewed in 1992 when the company was registered as a public limited company (Plc) with an authorized share capital of N5.5 billion all of which was fully paid.
The corporate mission of transcorp is to enhance national development and to maintain adequate return to its shareholders and the federal government of Nigeria.
- To ensure the developed of telecommunication technology as infrastructural facility for the economy development of the country.
- To improve the efficiency and availability of telecommunication services.
- To carry on for profit, the business of internal and external telecommunication.
- To general borrow or raise money.
For the purpose of the company’s business.
1.8 SCOPE AND LIMITATION OF STUDY
this research work is meant to carryout the analysis of financial statement of Transcorp Ltd from 1989 to 1993 to interpret amplify and translable the facts and data contained in the financial statements, the purpose being he drawing of relevant, conclusions therefore, making inferences as to business operations, financial position and future prospects which involves:
- Analysis of data contained in financial statement into certain basic component.
- Translation of data into clear simple from. This process will lead to extraction of ratios, or percentages that establish the relationship between comparable data and presentation of charts.
- Drawing relevant conclusion and making inferences from financial position, stability, profitability and solvency of the company.
- Presentation of information so obtained to management decision making. The information is used in the feed for warding and also in implementing controls and policies.
The researcher found it necessary to limit analysis to five years.
This obviously makes for more elaborate and more effective analysis that will yield more useful profitable result the managing director/chief executive of the company was also interviewed of find out more on the extent of adaptation of the company to the use of financial ratios.
A lot of money was spend on transportation from transcorp head Quarters, where most of the information and materials needed for this work was gathered and form few other office also in Enugu were visited for more efficient and effective information. This research work was faced with a lot of shortcomings, it was a frustrating experience, and firstly a lot of problems were encountered in data collection process since the study requires transcorps Annual Financial statement which is only made available to the managing director and the executive director of the company and other vital information necessary for management use.
Also there was a time constraints since the researcher was also involved in classroom work and other academic activities coupled with political and social activities involved around the campus areas.
Finally, it is anticipated that the services provided by transcorp are:
- Telephone services
- Telex services
- Bureaufare (facsimile) to transmission
- Private wires
- Lease circuits
- Data transmission
- Other service
1.10 DEFINITION OF TERMS
This consist of balance selected, profit and loss account or income statement, the notes on the accounts, sources and application of finds statement value added statement and historical financial summary.
RWF 5 STATEMENT OF ACCOUNTING STANDARD 2 PART 2 SECTION
This is a statement of the assets and liability of a company on a given day on the balance sheet.
Profit And Loss Account
This is a record of activities of a company for a given period of time, the period which is called the accounting period, is normally a year.
“The involves companying on figure against another to produce a ration and assessing whether the ratio indicates weakness or strength in the company’s affairs.
This is the general term for all economic resources owned by an entity Assets include. Money rescindable (claims on money to be received later). Products held for sales and long term asset used several years, such as building equipment, tools and vehicle.
REF 6 GEOFFREY HOLMES AND ALAN SUADEND INTERPRETING COMPANY REPORTS AND ACCOUNTS, 2ND EDITION (BRITAIN WODDHEAD, FAULKNER LIMITED 9182) PAGES 3 REF 7 GEOFFERY HOMES 7 ACCOUNT SEGDEN IBIS PAGE 3 FEF 8 ICAN STUDENT II FINANCIAL ACCOUNTING (LONDON, BPP PUBLISHING COMPANY 1988) PAGE 248.
“These are amounts of money owned to an outsider by an entity caused as a result of borrowing money that has to be repaid later or through buying assets and services on credit.
This includes cash temporary short term investment that could be quickly sold for cash and those assets directly involved in the entity’s operating system or cycle.
“Any liabilities payable within one or less is classified in the current liabities section which is listed first.
REF 9 JOHN A TRACY, FUNDAMENTAL OF FIN. ACCOUNTANCY 2ND EDITION (WILEY/HAMILTION & SONS INC) PAGE 10
REF 10 JOHN A. TRACY IBID PAGE 10
REF 11 JOHN A. TRACY IBID PAGE 41
REF 12 JOHN A. TRACY IBID PAGE 42
Correct assets minus current liabilities equals to working capital or to be more precise, net working capital.
“Distribution of profit by corporations to different shareholders, directors and stakeholders to the company.
REF 13 JOHN TRACY IBID PAGE 542
REF 14 JOHN IBID PAGE 44.
2.0 REVIEW OF RELATED LITERATURE
Having introduced the subject and having given the general background and purpose of the study. This chapter will now be devoted to the review of some related literature and studies on the subject.
Literature To Receive Include
“Write –ups”, “text-book” “journals by other authors and researchers the subject.
2.1 TYPES OF FINANCIAL RATIONS
This section will examine some of the financial ratios in today’s use. However, it should be noted that only a few was treated here.
This is because financial ratio are very numerous and giving an exhaustive list is not the objectives of this study. Moreover, companies are not bound to use all the available ratios, in their analysis before they could get the information required. Using this system of ratio analysis will be costly and time consuming so all they need is to analysis only a few and reach a decision based on them.
Financial ratios may be classified based on the sources of data and these are as follows:
- Trading account ratios.
- Profit and loss account ratios.
- Balance sheet ratios.
- Trading account to profit and loss account ratios.
- Trading account profit and loss account ratios.
The four main categories of financial ratios are:
- Short term solvency and liquidity ratios.
- Long term solvency and stability ratios
- Efficiency and profitability ratios.
- Potential and growth ratios.
The various types of financial ratios are then derived from the expansion of the categories.
2.1.1 SHORT-TERM SOLVENCY AND LIQUIDITY RATIOS
The ratios measure the ability of he firm to meet its obligation as they become due. The liquidity ratios by establishing a relationship between cash and other current assets to current obligations prove a quick measure of liquidity. An excess liquidity will result in bad credit ratings and loss of confidence by creditors. It is necessary to otrike on balance between liquidity and lack of liquidity.
- Current ratio Current assets current liability
Current ratio is a measure of liquidity of solvency.
Neston and Brigham 16 states that current ratio indicates the extent to which the claims of short term creditors are covered by assets that are expected to be converted to cash in a period roughly corresponding to the maturity of the claims.
This is computed by dividing current assets by current liabilities. Current assets include cash, marketable securities; accounts receivable and inventories. Current liabilities consist of accounts payable notes payable accrued income and taxes, short-term loans etc.
- Quick or acid test ratio= current assets inventory
“This test is the acid-test ratio, also known as the “quick ratio” because it is assumed to include the assets most quickly convertible into cash.
The omission of inventories from the acid test ratio is based on the belief that is the least liquid component of the current assets group”.
Also, Neston Brigham “states that this is a measure of the firms ability to pay of short term obligation without relying on the sales of investors or assets. It is the same as current assets figure because it is the lowest to realize that is, it is least liquid current assets.
- inventory turnover ratio = sales
or cost of goods sold.
“The inventory turnover ratio measure the average rate of speed with which inventories moves through and out of the enterprises.
“The also indicates the velocity at which the trading stock is being sold or turned over” 18 Neston and Brigham” identify two problems that arises.
a………. in calculating and analyzing this ratio first, sales are at market price, if inventories are carried at cost, as they are generally are; it would be more appropriate to use cost of goods sold in place of sales in the numerator of the formulae.
The second problem lies in the fact that sales occur over the entire year, whereas the inventory figure is for one point at the period. This make it better to the use of an average of the begin and ending inventories in the denominator.
In calculating and analyzing this ratio 1st before firstly sales are at market price, if inventories are carried at cost, as they are generally are’ it would be more appropriate to use cost of goods sold in place of sales in he numerator of the formulae.
The second problem lies in the fact that sales occur over the entire year, whereas the reventory figure is fore one point at the period. This makes it better to the use of an average of the beginning and ending inventories in the denominator.
- Average collection period (in days)
Receivable x 360
This shows the rate at which trade debts are collected, westan and Brigham 19 sees it as the average length of time that the firm must wait after making a sales before receiving cash if the sales was in credit basis.
- Total assets turnover = sales
This show the relationship between the volume of business and the size of assets invented.
2.1.2 LONG TERM SOLVENCY AND STABILITY RATIOS
These ratio measures the fund supplied by the owners of the business as compared to the finance provided by the firms creditors. As a general rule, there should be an appropriate mix of debt and equity in financing the firms assets from the creditor point of view a light incidence of owner financing is desirable because creditors 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 finds can be used by the business to generate earnings in excess of interest charges, those funds, then borrowing has benefited the owners.
This ratio can be approached in two ways. One approach examines balance sheet ratios and determines the extent to which borrowed funds have been used to fiancé 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 down turn, but they have lower expected returns when the economy booms. Conversely, firms with high leverage ratios run the risk of large losses but also of large losses but also have a change of gaining high profit. These ratios include.
Ebit –Earning before interest and taxes.
- Fixed interest coverage
= 2/3 net profit appreciation
This indicates the umber of times the fixed interest charges are covered by net operating profit. This ratio is similar to the times interest earned ratio, but it is some what more inclusive in that. It reorganizes that many firm lease assets and incure long turn obligations under lease contracts.
- Fixed divided coverage =
net profit after tax
This indicates the number of times fixed dividends are covered by taxed profit.
- Proprietary ratio = Shareholders fund
total assets (tangible)
This shows the extent or degree to which shareholders are protected against loss in the event of liquidation.
- Earning = fixed interest leans + preference
Every share capital
This indicates the degree of volubility of earnings available for ordinary shareholder. “The gearing is the action, between fixed interest borrowing and the ordinary shareholders, whose divided many vary with the earned available for distribution.
“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 I the numerator. The stake of the owners in the business vis–a -vis that creditors must be reasonable enough to enable the owners to take control of the business with high sense of responsibility.
2.1.3 EFFICIENCY AND PROFITABILITY RATIOS
These ratios examine how efficiency the firm is being managed.
The managers creditors shareholders, as well as the employees of the firm interested in the profits of the firm some ratios measure profitability are:
Gross profit managing = Grass profit x 100
This ratio is normally used along with gross profit. Margins and its show management efficiency in manufacturing administering and selling the products.
- Profit to capital employed or rate of return EBIT
“This indicate overall profitability of the business,. 23.
Tracy 24 in his work also sees thus ratio as the most important profit performance measure for a firm.
- Return on net worth = Net profit after tax
This ratio measures the rate of return on total investment in the firm and is also called return on investment (ROL) – MEIGS 25. States that return on assets is an important test of management ability to earn returns on fund supplied from all sources.
Tracy 26 has this contribution to make his ascertain that return on assets in a second basic return on investment measure being the ratio of rearming on the total assets used up by the firm.
This is regarded internationally as an indicator of future performance Douglas 28 prove that this ratio compares the average price of the share to the reported earning per share.
- Dividend per share (DPS) =
Total dividend (N)
Number of ordinary share
This is a measure of dividend policy of the company. This ratio is as important as the earning per share, the reasons for their warren 28-who primary basis for dividend-earning per share data can be presented in conjunction with dividend per share data to indicate the relationship between earnings and dividend and the extent to which the corperation is retaning its earnings for use in the business Reg 27 Doughlas carboult. Op at ref no 19 page 2915.
- Dividend pay-out ratio =
Dividend per share (DPS)
Earning per share (EPS)
This shows that retention policy of company.
2.2 METHODS OF ANALYZING FINANCIAL RATIOS
Having treated some of the various financial ratios in use, the various method of analyzing them will now be examined.
These are four ways of analyzing financial ratios.
- Time series
- Cross sectional analysis.
- The residual method
- The multivariable ratio analysis
the objective of analyzing a time series (chtra-firm) of financial ratios is to predict values of the ratios. The general approach to time series prediction is to search for systematic pattern in the historical behaviour of the series, the knowledge of which can be used in the prediction process.
Cross sectional (inter-from) Analysis the objectives of this method of analyzing financial ratios is to derve information needed for financial decision by companying the investigated ratios with exogenous norms or standards. Comparison with industry-wide measures is known as the standard ratio technique.
This is the third method of ratios and it is a combination of time series and cross sectional analysis. This is used for studying the behaviour of stock provision basic premise underlying this method is that if the investigated variable e.g (stock prices) is cross sectional correlated its variability can be decomposed into two parts.
- The one that is caused by general factors
- The one that is caused by specific factors affect only the firm under studying.
The part that is caused by specific factors affect all the firm while the one affected by specific factors only the firm under studying.
Multivariate Ratio Analysis
This is the fourth and final method of ratio analysis and it arises as a result of the limitations of a financial ratio analysis restricted to one ratio (that is infuriated). It was recognized and shown that a comprehensive evaluation of the firm economics situation required an examination of several key ratios read studding height on a specific aspect of his firms operation.
The main characteristics of the multivariate approach is the simultaneous consideration of several ratios in the analysis.
2.3 ADVANTAGE OF FINANCIAL RATIOS
The advantages of financial ratios are inherent in the various assistance which they offer to managers investors and creditors.
- Use by Management
Financial ratios are very useful to various levels of management. Generally management will wish to be alerted to potential liquidity crisis and overall productivity of the firm in other to decide on the corrective active to be taken.
The production manager needs to have up to date data, not only on the production ratio of his own department but also on the pertinent items that will enable him to examination efficiency and full reutilization of productive ability.
The sales manager normally requires ratio which link the output of the firms or its constituent department to the income generated by the firm or the various departments that makes up the firm to help in assessing the degree of changes in sales and income.
The general manager is concerned with the decomposition of the expenses to help him in the general administration of the firm and to rectify any excess expenditure.
Conclusively, the management of any organization s normally more interested in the following ratios.
- Return on capital employed.
b Profit margin
- Assets turnover
- Use by Investors
These include actual and potential shareholders of the firm, they are concerned with the profitability risk and market share performance of the firm. The investors will wish to make decision on whether or not to invest in the company. A good decision on whether or not to invest in the company can only be made after studying the financial ratio, of the firm.
The investors are normally more interested in the following ratios.
- Net following ratios
- Dividend yield
- Dividend cover
- Earning per share and
- Price earning ratio
- Use by Creditor
The creditors of a business include debenture holders, mortage institutions, long term lenders, finance houses, banks, commercial banks, trade and sundry creditors.
Financials ratios are used by creditor as for security and credit analysis purposes.
In security analysis, the long run profit potential of the firm is judged and the merits of the firms stock and bounds are analysis in order to decided on whether, or not to grant credit. Also, due to the risk involved in extending credit, banks and other lender will wish to be assured of the ability of the firm to repay short term loans and overdrafts before making any advances.
In credit analysis, the credit manager is concerned with ratio which shows whether prospective buyer will pay promptly or not. Ratios usually required here are the liquidity, leverage and profitability ratios which assist creditors in making decision on whether to grant credit or not.
2.4 DISADVANTAGES OF FINANCIAL RATIOS
Though financial ratios provide a consistent and disciplined approach to the analysis of accounts, the dangers in accepting answers which appear to be put forward by ratios are too rigid in a manner.
The following are the limitations associated with financial ratios.
- Inadequacy of Source of Data: The sources of data, that is the reports for which financial ratios are computed are sometimes not available at the right time. For instance, some figures used like stock, profit, debtors, creditors etc. are that of the end of the period and do not show the level that really existed throughout the trading period.
- Shortage Of Published Information: The reports do not give the credit sale and purchases and the items of payments leading to wrong figure being used in some computations.
- Variety Computations: Used in ratio analysis have been defined in various ways by various authorities leading to misunderstanding of one ratio.
- Method of Computation: There are varieties of formulae used in computation of these ratios problem arises as to which one is the best.
- Terminology: Many ratios are called by different names by different analysis, sometimes this leads to rowing computations and wrong results.
- Miscellaneous: In dividend items of ratios are also affected by various factors which reduces the reliability of ratios as analytically tool. Sales is affected by the operation of cut off procedure and treatment of retinues, like purchases etc. assets are affected to property, valuation and method of depreciation profit is affected by mark ups.
29 finally it was the states that the three limitations of financial ratios analysis for predicting business failure are as follows:
- While ratios might show that there is something wrong and while a sequence of them overtime may show it is getting worse, it is doubtful whether one could predict collapse on the evidence of these ratios alone.
- The value of ratios have been eroded by inflation figures that appear to show an improvement in real terms.
- Managers start “creative accounting” when they know that things are wrong.
Creative accounting involves making the company’s result look better than they were for example, by cutting expenditure on routme maintenance or by understanding liabilities and over standing profit.
2.5 RELIABILITY OF RATIO ANALYSIS
The reliability of ratio analysis has a direct relationship with the accuracy of the figure employed in the computations of the ratios invariability of ratio analysis was what made it inevitable that a review on the literature of the pertinent ratios was carried out, as this has readily and lucidity highlighted the reliability and the unreliability factors.
2.6 FACTORS THAT AFFECT RATIO ANALYSIS
Though the ratio analysis of NITEL PLC would be conducted, it would be interesting to bear in mind that there might be an effect or influence of some invisible hands in those areas where they had poor or unfavorable performance.
These invisible hands are:
- Depreciation differences and its affect or assets.
- Inventory method and effect. The methods commonly used include: lifo, lifo on the average cost inventory valuation method.
iii. Result valuation due to different accounting methods used.
- Consolidated and non consolidated balance sheet.
- Capitalization and non apitalization of leases.
- Depreciation value of the naria.
2.7 MANAGEMENT DECISION
It was stated in Akpala’s book 30-“ that management decision emanates from the board of director or other governing body and is communicated downwards through the managing director to enable action to be taken at every appropriate level of administration below. In every company, there are a number of important issues that require the attention of top management and the board of directors. These gives rise to fundament policies that emerge from the basic objectives related to organization functional means or units inform of marketing and sales.
Policies, production polices, financial policies and personal policies.
Management decision refers to those decision taken by the management personal of any organization through a process of selection from among alternatives. The various stages of management decision has been taken care off in chapter one of this work. Now, let me discuss the criteria for selecting from alternatives.
Selecting from Alternatives
To decide on which alternative is most feasible, we must examine each of the alternative using the proper criteria and they are not optional. Every one of these criteria must be judged in the light of all relative criteria and a consequence them into consideration at the time he/she does a proper job of considering each criterion.
These Criteria are:
- Benefits: To apply this criteria affectively we must specify exactly what benefit we must derive by choosing any given alternating we must ask, what kind of revenue are going to accuue to the company? Is the turnover of the inventory going to be improved will expenses be reduced? Is the discrimination problem to be overcome? Etc.
- Cost: The decision maker should make sure that he/she has determine all types of cost for every alternative. Like benefit, the cost criterion must be specified exactly. How much are we going to have to pay for this planned expansion? What are the selection training and recruitment? The cost of making good forecast has been weighted against the possible cost of a bad decision.
- Timing: The next factor to consider is timing. When are we going to realize the benefits? When are we going to have to pay the cost? Is the cost to be incurred derived in some future period? It makes a lot of differences whether we get a naira now or in ten years from amounts of benefits and cost should be clearly understand by the decision maker consideration, as well as assets depreciation and obsolesce.
The decision maker must be sure that he is comparing all the alternatives which he/she to be feasible in the same time frame for each alternatives. The decision maker should have an appreciation of present value concepts so that he/she is properly recognizing the effect of time.
- Profitability: We rarely know that anything about the future is with complete uncertainty, we have to consider the changes or probability that the demand for the product will be high or low.
Although, the mathematics of probabilities may be complex, the concept is not having decided upon feasible alternatives. The decision maker should estimate the expected value of the result of each alternatives. He /she should certainly understand the concept of profitability and take it into consideration.
- Risk: The decision maker ought to make a conscious effort to analysis attitude toward risk and attempt to assure that his attitude is appropriate relative to the attitude of those who will judge his/her decision.
- Compromise: Every decision makers relaxes that at times he/she to compromise with the decision he/she would like to make, perhaps, for example, he /she thinks that the best alternatives, everything else considered us to automate the plan. However, he/she is aware from past experience that would be very opposed to this and as a consequence he/she decide to compromise. Compromise is a way of life for good decision makers.
However, a decision maker should realize he/she begins to compromise.
- Politics: This decision maker have to consider the comparative polities of various alternative. Company politics like compromise is a way of like. Ignoring polities will not make the decision easier, people’s felling and attitudes must be considered, therefore, the decision maker should always recognize the polities of his/her decision(s). It is very good to put consideration when making decision than to run rough-shod over their feelings without recognizing them. He/she should analyse how each of the people who are interested in the decision made and the selection for the alternatives feel about he matter, he/she should weight their positions in making decisions.