A CRITICAL ANALYSIS OF THE USE OF FINANCIAL STATEMENTS IN ASSESSING THE PERFORMANCE OF AN ORGANIZATION

CHAPTER ONE

INTRODUCTION

1.1       Background of the Study

Financial Analysis is the process of assessing the financial position of a company by analyzing its stability, viability and profitability. One of the primary objectives of financial analysis is to recognize changes in financial trends, to help measure the progress made by an enterprise and identify a relationship to draw a logical conclusion on the performance of the company. Another major aspect of a financial analysis is comparing the performance of the company with its competitors (Laitinen, 2002). Financial performance could be defined as a measurement of the results of a firm’s polices and operations in monetary terms. In assessing the overall financial condition of a company, the income statement and the balance sheet are important reports, as the income statement captures the company’s operating performance and the balance sheet shows its net worth. Financial performance could be assessed using the following key measures which are important to assess the current financial position and performance. These are descriptive and analytical measures of financial position and performance. That includes current assets, current liabilities, total assets, stockholders equity, total revenues, total expenses and net income. And analytical measures of financial position and performance could include profitability measures. Financial statements are vital tools of operations for business entities and organizations. The balance, sheet, income statement and the statements of cash flow are some of the integral tools in financial statements. The executives, investors, managers, and creditors of various business entities often use such tools to evaluate companies’ previous performances and fiscal standings at different times (Cheatham & Cheatham, 1993). The financial statements usually present economic records that are routinely analyzed to inform stakeholders’ decisions on critical matters related to companies’ operations. The understanding financial statement is, therefore, indispensable for an organization that strive to have clear financial records that form the foundations for successful business transactions. Various techniques of executing financial statement analyses do exist (Cheatham & Cheatham, 1993). The accountants use the accounts after the adjustments have been made to prepare the financial statements. These statements represent the output of the accounting system, and are statements that provides valuable source of information for business managers and all who work within the business, also for potential investors and their business. The financial assets of a business merely represent claims on real estate and also the financial asset play a very crucial role in economy. They are usually compiled on a quarterly and annual basis. Therefore the general purpose of a financial statement is aimed to meet the need of a wide range of users. The principal financial statements of a corporation are income statement (profit and loss) and balance sheet can be prepared directly from the adjusted accounts, (Gibson, 2013). The balance sheet is static like snapshot, reflects conditions on specific date of its preparation, records the categories and amount of assets employed by the business and offsetting the liabilities incurred to lenders and owners. Also is called statement of financial conditions, it must always balance. By definition, the recorded value of the total assets invested in the business at any point in time must be matched precisely by recorded liabilities and owners’ equity, (Helfert, 2003). Meanwhile, the income statement reflects the effects of management’s operating decisions on business performance and the resulting accounting profit or loss for the owners of the business over specified period of time. The income statement also is known as profit and loss statement or operating statement displays the revenues recognized for a specific period, and the costs and expenses charged against these revenues, (Helfert, 2003). Income statement or profit and loss account is considered to be the traditional tool for assessing the company’s performance. Most companies and institutions have as main objective to maximize their profits, so traditionally the firm performance is evaluated based on profits, reflected in the profit and loss account. The Income statement gives a retrospective view of the operations that influenced the financial position and explains the way the result of the exercise is formed as an expression of partial or global adjustments between different types of income and expenses. Financial statements serve three important economic functions: (i) they provide information to the owners and creditors of the firm about the company’s current status and past financial performance, although rarely provide enough information; (ii) financial statements provide a convenient way for owners and creditors to set performance targets and to impose restrictions on the managers of the firm; and, (iii) they provide convenient templates for financial planning, managers can check the overall consistency of separate plans made on a project-by-project basis and estimate the firms total financing requirements (Bodie et al 2009).

1.2       Statement of the Problem

Although financial statements shows the financial positions of a business at the end of a financial period, but they do not present accurate performance on the level of performance or efficiency of operations of a business at the end of financial period. It is usually observed that the operating profit figure of a company might be higher in the current year than the previous year but this higher profit figure cannot be used to say the company has performed better in the current year than in the previous because the cost of the asset is being considered at the beginning of that first year which may reduce the profit for that period. If it is judge based on this, it will have adverse or negative impact on the investment or investors. Many investors in Nigeria are uneducated or illiterate and as a result of ignorance or inexperience, they cannot use or employ financial ratios in evaluating the performance of the companies. Also existing shareholders use the cash dividends and interest paid to them in evaluating the performance of the companies for investment decision. These parameters do not give accurate information about the performance and efficiency of operation of the companies.

1.3       Objectives of the Study

The study sought to critically analyze the use of financial statements in assessing the performance in an organization. Specifically, the study sought to;

1. find out the role of financial statement in determining profitability performance of an organization.
2. find out how the use of financial statement analysis assists organizations in identifying investment opportunities.

iii.   examine whether financial statements are essential instruments for a sustainable growth pattern of organizations.

1.4       Research Questions

1. What is the role of financial statement in determining profitability performance of an organization.
2. Can the use of financial statement analysis assists organizations in identifying investment opportunities?

iii.   How do financial statements essential instruments for a sustainable growth pattern of organizations?

1.5       Significance of the Study

This study will be of immense benefit to other researchers who intend to know more on this study and can also be used by non-researchers to build more on their research work. This study contributes to knowledge and could serve as a guide for other study.

1.6       Scope/Limitations of the Study

This study is on critical analysis of the use of financial statements in assessing the performance in an organization.

Limitations of study

Financial constraint: Insufficient fund tends to impede the efficiency of the researcher in sourcing for the relevant materials, literature or information and in the process of data collection (internet, questionnaire and interview).

Time constraint: The researcher will simultaneously engage in this study with other academic work. This consequently will cut down on the time devoted for the research work.

1.7       Definition of Terms

Analysis: Detailed examination of the elements or structure of something.

Financial Statement:  Financial statement is the combination of the three major reports on a business. It will contain the cash flow statement, the income statement and the balance sheet of the business.

Organization Performance: Organizational performance comprises the actual output or results of an organization as measured against its intended outputs (or goals and objectives).

References

Bodie, Zvi, Robert C. Merton, and, David L. Cleeton (2009). Financial Economics, Person Prentice Hall, London, 2nd Edition.

Cheatham, L. & Cheatham, C. (1993). Utilizing Financial Statements as Cash Flow Planning and Control Tools. Managerial Finance, 19(8), 35-49.

Gibson, Charles H. (2007). Financial Reporting and Analysis: Using Financial Accounting Information. Thomson South-Western, 10th Edition.

Helfert, Erich A. (2003). Techniques of Financial Analysis: A Guide to Value Creation. McGraw Hill, 11th Edition.

Laitinen, Erkki K. (2006). Financial Statement Analysis of a Network of SMEs: towards measurement of Network Performance, International Journal of Networking and Virtual Organizations, 3, No.3, 258 – 282.

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