Professional Documents
Culture Documents
Introduction
This chapter includes what other researchers have written about financial statement
analysis, the concepts and other terms related to the researcher topic. This entails mainly the
definitions and all the necessary details about the financial ratios, and companys performance,
their analysis and interpretation. This result in the fact that the financial analysis is based on the
information contained in the financial statements and the financial analysis is all about the analysis
interpretation of this information to get clear and more meaningful understanding of the financial
position of the firm which is one of the most indicators of a companys performance.
Financial statements are most widely used and most comprehensive way of communicating
financial information about a business enterprise to uses of the information about a business
enterprise to uses of information provided on the reports. Different uses of financial statements
have different information needs. General- purpose financial statements have been developed to
meet the needs of uses of financial statements, primarily the needs of investors and creditors
(Charles, 1993).
2.1.2. The importance of financial statement
As stated by Reeves, (2011) financial decisions are typically base on information generated
from the accounting system. Financial management stockholders, potential investors and creditors
are concerned with how well the company is doing. The three reports generated by the accounting
system and include in the company annual report are the balance sheet, income statement and
statement of cash flows. Although the form of these financial statements may vary among different
The balance sheet portrays the financial position of the organization at particular point in
time. It shows what you own (assets) how much you owe to vendors and lenders (liabilities) and
what is left (assets minus liabilities known as equity or not worth) A balance sheet equation can
be started as: Asset-liabilities= stockholders equity. The income statement, on the other hand,
measures the operating performance for a specified period of time. If the balance sheet is a
snapshot the income statement serves as the bridge between two consecutive balance sheets.
Simply put balance sheet indicates the wealth of your company and income statement tells you
how your company did last year. The balance sheets and income statement tell different thing
about company. The fact company made a big profit last year does not necessarily mean it is liquid
(has the ability to pay current liabilities using current assets) or solvent (non current assets are
Information from financial statements is necessary to prepare federal and state income tax
returns. Statements themselves need not be filed. Prospective buyers of a business will ask to
inspect financial statements and the financial/operational trends they reveal before they will
negotiate a sale price and commit to the purchase. In the event that claims for losses are submitted
to insurance companies, accounting records (particularly the Balance Sheet) are necessary to
substantiate the original value of fixed assets. If business disputes develop, financial statements
may be valuable to prove the nature and extent of any loss. Should litigation occur, lack of such
statements may hamper preparation of the case. Whenever an audit is required--for example by
owners or creditors--four statements must be prepared: a Balance Sheet (or Statement of Financial
Income Statement (or Statement of Earnings), and Statement of Cash Flows. A number of states
require corporations to furnish shareholders with annual statements. Certain corporations, whose
stock is closely held, that is, owned by a small number of shareholders, are exempt. In instances
where the sale of stock or other securities must be approved by a state corporation or securities
agency, the agency usually requires financial statements. The Securities and Exchange
Commission (SEC) requires most publicly held corporations (such as those whose stock is traded
on public exchanges) to file annual and interim quarterly financial reports (Deltacpe, 2014).
Financial Statements represent a formal record of the financial activities of an entity. These
are written reports that quantify the financial strength, performance and liquidity of a company.
Financial Statements reflect the financial effects of business transactions and events on the entity.
The income statement provides a financial summary of the firms operating results during
specific period. Most common are income statement covering one year period ending at specific
date, ordinary December 31st of the calendar year. In addition monthly statement is typically
prepared for used by the management, and quarterly statements must make available to the
stockholders of publicly held corporations. The recognition measurement and reporting of business
income and its components are considered by many to be the most important tasks of accountants
(Alfred, 2013).
The uses of financial statements that must make decision regarding their relationship with
the company are always concerned with a measure of its success in using the resources committed
to its operation. Has the activity been profitable? What is the trend of profitability? Is it increasing
profitability or is there a downward trend, what is the most probable result for future years? Will
the company be profitable enough to pay interest on its debt and dividends to its stockholders and
The balance sheet presents a summary of the firms financial position at a given point in
time. Which are the debts of the firm; and stockholders equity, which are the owners interests in
the firm? The income statement, however, tells part of the financial story; it does not answer
question such as: what is the company doing with its income? How is the company being financed?
How in debt is the company? And how liquid are its assets? To answer these equations, an external
uses has consider the balance sheet or statement of financial position. The balance sheet is
In financial accounting, a cash flow statement, also known as statement of cash flows or
funds flow statement, is a financial statement that shows how changes in balance sheet accounts
and income affect cash and cash equivalents, and breaks the analysis down to operating, investing,
and financing activities. The statement of cash flows provides a summary of the cash flows over
the period of concern, typically the year just ended. The primary purpose of the statement of cash
flows is to provide information about cash receipts and cash payments of an entity during a given
period. The statement can be prepared frequently (monthly, quarterly) and is a valuable tool that
summarizes the relationship between the Balance Sheet and the Income Statement (Gitman, 2009(
Many small business owners and managers find that the cash flow statement is perhaps the
most useful of all the financial statements for planning purposes. Cash is the life blood of a small
business if the business runs out of cash chances are good that the business is out of business.
This is because most small businesses do not have the ability to borrow money as easily as larger
business can.
According to the FASB, The information provided in the statement of cash flows, if used
with the related disclosures and information in other financial statements should help investors,
creditors and others to assess an entitys ability to generate positive future net cash flows, and to
meet its current and long term obligations, including possible future dividend payments.
Essentially, the cash flow statement is concerned with the flow of cash in and cash out of
the business. The statement captures both the current operating results and the accompanying
changes in the balance sheet. As an analytical tool, the statement of cash flows is useful in
determining the short-term viability of a company, particularly its ability to pay bills. By
understanding the amounts and causes of changes in cash balances, the entrepreneur can
realistically budget for continued business operations and growth. For example, the Statement of
Cash Flows helps answer such questions as: Will present working capital allow the business to
There are various parties who hold vested interest in an organization and hence require the
formation provided by financial statements to ensure the security of the interests. These parties
will also need financial statement information to facilitate decision making, monitoring of
management or to interpret contracts and agreements that include provisions based on such
Forza, (2000) described the following users of financial information who are: shareholders,
managers, directors, external auditors, suppliers of long term debt and financial institution,
government, competitors, recruiter and consultants, trade unions, investors, the public, creditors,
banks.
Shareholders: Shareholders are those people who invest in the company, require information for
share trading decisions and for generally evaluating the performance of the organization. As they
are the owners of the company, they also interested in how the directors are managing it on their
Managers: The managers are interested in the overall performance of organization. Managers are
likely to be interested in information about their own part of the organization and will find
management accounting information particularly useful. This helps managers to measure the
effectiveness of its policies and decisions, determine the the advisability of adopting new policies
and procedures and documents to owners the results of managerial efforts as it is their overall
responsibility to see that the resources of firm are used efficiently and effectively(Vieira, 2010).
Directors: As elected representatives of the shareholders, they are responsible for protecting the
share holders interests by vigilantly overseeing the companys activities This demands an
understanding and appreciation of financing investing, and operating activities both business
analysis and financial statement analysis aid directors in fulfilling their oversight responsibilities.
External auditors: The product of an audit is an expression of opinion on the fairness of the
clients financial statements. At the completion of an audit, financial statement analysis can serve
as a final check on the reasonableness of financial statement as a whole. Auditors also use credit
analysis in evaluating the ability of their client to remain a going concern (Petkov, 2012).
Suppliers of long term debt and financial institution: They can ascertain on the basis of interest
coverage ratio. Whether the company will pay interest regularly or not, and on the basis of the debt
equity ratio. They can examine the capital structure of the company to ascertain whether the
company will be able to repay their loan and the principal according to its terms and to know the
Government: The government needs information to estimate the effects of existing and proposed
taxation and other financial and economic measures. It also needs information to estimate
Competitors: They want a scoop on profitable lines business and profit margins, so they can
perhaps come in to compete. Management wants to conceal sensitive information, but generally
Recruiter and consultants: They want consulting gigs to asses companies and industries hire
away the best managers and generally milk the cash cow that a long corporation.
Trade unions: They are interested in the stability and profitability of organization they are
working in. The techniques of financial statement analysis are useful to trade unions in collective
Investors: This group is concerned with the firms earnings, they concentrate on the analysis of
the firms present and future financial structure and at which extend it influences the firms
The public: The public may wish to have information about the role of the organization as an
employer, its contributions to political and charitable groups, and the impact of its activities on the
Creditors: Creditors will normally be suppliers who will be interested to see if the firm is meeting
its demands and in a position to pay its suppliers. Future contracts could depend on such issues.
Banks: Banks are interested in the financial information published by the firm as they will gain
insight into how capable the firm is of paying back any loans or mortgages they may have currently
As stated by Harrington, (1993) they are three important sets of techniques or tools for
statement analysis by reviewing consecutive balance sheet, income statements of cash flows period
to period. This usually involves a review of changes in individual account balances on year to-
year or multi year basis. The most important information often revealed comparative financial
statement analysis is trend. A comparison of statement over several periods can reveal the
direction, speed, and extent of a trend. Comparative analysis also compares trends in related items.
Comparative financial statement analysis also is referred to as horizontal analysis given the left-
right or right analysis of account balances as review comparative statements (Houston, 2009).
Common size financial statement analysis: The figures reported in financial statement
under this kind of analysis are converted into percentages to some common base specifically, in
analyzing a balance sheet; it is common to express total assets (or liabilities plus equity) as 100
percent. Then accounts within these groupings are expressed as a percentage of their respective
total. In analyzing an income statement, sales are often set at 100 percent with the remaining
income statement accounts expressed as a percentage of sales. Since the sum of individual accounts
within groups is 100 percent, this analysis is said to yield common-size financial statements. This
procedure also is called given the up-down (or down-up) evaluation of accounts in common size
statement is useful in understanding the internal makeup of financial statement (Kalem, 2012).
proportionate changes in accounts within groups of assets, liabilities, expenses, and others
categories. Common-size statements are especially useful for intercompany comparison because
financial statements of different companies are recast in common size format. Comparison of a
companys common size statements with those of competitors, or with industry averages, can
Financial ratio analysis: Financial ratio analysis has been used to assess company
performance for almost as long as modern share markets have been around. The methods are based
on tried-and-true accounting ratios which have been around for even longer. The theory of
financial analysis was first popularized by BINJAMIN GRAHAM who is considered by many to
be father of fundamental analysis. BINJAMIN GRAHAM, who from 1928 was a professor at
Colombia business school as well as a very successful investor in his own right, was mentor and
Ratios are most widely used tools of financial analysis, due to they provide clues to and
symptoms of underlying conditions. Like other analysis tools, ratios are usually future oriented,
and it helps accountant analysts to uncover conditions and trends difficult to detect by inspecting
individual components making up the ratio. Besides, a ratio expresses a mathematical relation
between two quantities. It can be expressed as a percent, rate as well as proportion. Moreover,
usefulness of a ratio analysis fully depends on a users skillful interpretation. The ratio analysis
can be used to evaluate three fundament qualities of a company: liquidity, solvency and
Financial ratio can be grouped into four types (liquidity, efficiency, Investment, and
profitability). No one ratio gives us sufficient information by which to judge the financial condition
and performance of the firm. Only when we analyze a group of ratios are we able to make
reasonable judgments.
Liquidity ratios measure your company ability to cover its expenses. The two most
common liquidity ratios are the current ratio and quick ratio. Both are based on balance sheet
(Foster, 2009).
Current ratio: According to Handan, (2009) the current ratio measures a companys ability to
repay short-term liabilities such as accounts payable and current debt using short-term assets such
as cash, inventory and receivables. Another way to look at it would be the value of a companys
current assets that will be converted to cash over to the next twelve months compared to the value
of liabilities that will mature over the same period. The current ratio is useful as it shows whether
a company has adequate resources to repay short-term debt or if it will experience cash flow
Current ratio=
Generally a current ratio of two times or 2:1 is considered to be satisfaction. The current ratio gives
the margin by which the value of the current assets may go down without creating any payment
problem for the firm. This represents a margin of safety for liabilities. A lower current ratio means
that company may not be able to pay its bills on time, while a higher ratio means that company has
money in cash or safe investment that could be put to better use in the business.
Quick ratio or acid-test: The quick ratio, also known as the acid test-ratio, is a conservative
variation of the current ratio, the quick ratio measures a companys immediate debt-paying ability
only cash, receivable, and current marketable securities (Quick assets) are included in the
numerator. Less liquid current assets, such as inventories and prepaid expenses, are omitted.
Inventories may take several months to sell, prepaid expenses reduce otherwise necessary
Quick ratio=
Cash ratio: Since cash is the most liquid asset, a financial analyst may examine the cash ratio and
its equivalent to current liabilities. Trade investment or marketable securities are equivalent to cash
+
. Cash ratio=
According to Jennings, (2001) activity ratios are also called turnover ratios. Activity ratios
are employed to evaluated the efficiency with which the firm managers and utilizes its assets. They
indicate the efficiency or speed with which the capital employed is being converted or turnover
into sales. Activity ratios, thus, involve a relationship between sales and assets. A proper
relationship between sales and assets generally reflects that assets are managed well. Several
activity ratios can be calculated to judge the effectiveness of assets utilization. Higher the rate of
turnover ratio indicates the greater profitability and better use of capital.
Inventory turnover ratio: The inventory turnover ratio, is a test of efficient inventory,
management, and indicates the speed with which the stock is being sold.
Inventory turnover ratio=
This higher inventory turnover ratio, the better it is, that is, quick movement of stock and lower
ratio indicated slow movement of stock, which means locking up of working capital. The concept
of inventory turnover ratio can be extended to find out the number of days of inventory holding
(Jennings, 2001).
and credit policies of the firm. The receivable turnover ratio reveals the velocity of receivables. It
Receivable turnover ratio=
The higher the ratio indicates that debtors are good and debt collected is working efficiently.
Evaluation of receivable turnover ratio can be made better and meaningful in term of average
365
Average collection period=
It indicates how quickly and efficiently the debts are collected. The shorter the period, the better it
is and longer the period, the chance of bad debts (Maheshwari, 2009).
Payable turnover ratio: It shows the velocity of debt payment by the firm. It is calculated as
follows:
Payable turnover ratio:
365
The average payment period:
This can be meaningfully evaluated by comparing it with the credit period allowed by the supplies.
To the extent possible, a firm should try to maintain the APP, Which is approximately equal to the
credit terms of the supplier. It improves goodwill and credit worthiness of the firm in the market
(carcello, 2008).
2.1.6.3 Solvency ratios
Leverage ratios, also referred to as gearing ratios, measure the extent to which a company
utilizes debt to finance growth. Leverage ratios can provide an indication of a companys long-
term solvency. Whilst most financial experts will acknowledge that debt is a cheaper form of
financing than equity debt carries risks and investors need to be aware of the extent of this risk.
Leverage ratios may be calculated from the balance sheet items to determine the proportion of debt
in total financial. They are also computed from the profit and loss account items by determining
the extent to which operating profits are sufficient to cover the fixed charges (Joel, 2009).
Debt to Equity ratio: The debt to equity ratio provides an indication of companys capital
structure and whether the company is more reliant a borrowing (debts) or shareholders capital
(equity) to fund assets and activities. Contrary to what many believes, debt is not necessarily a bad
thing. Debt can be positive, provided it is used for productive purposes such as purchasing assets
and improving process to increase not profit. Acceptable debt to equity ratios may also vary across
industries. Generally, companies that are capital intensive tend to have higher ratios because of the
Debt to total assets ratio measures the percentage of a companys assets that are financed by debt.
It is computed by dividing total liabilities by the total assets. (Edmonds et al. 2006)
Profitability ratios measure a company performance and provide an indication of its ability
to generate profit. As profits are used to fund business development and pay dividends to
Gross profit margin: Gross profit margin tells us what percentage of a companys sales revenue
would remain after deducting the cost of goods sold. This is important as it helps to determine
whether the company would still have enough funds to cover operating expenses such as employee
benefits, lease payments, advertising and so forth. A companys gross profit margin may also be
viewed as a measurement of production efficiency. A company with a gross profit margin higher
than that of its competitors or industry average is deemed to be more efficient and is therefore all
Gross profit margin= 100
Net profit margin : Net profit margin meanwhile indicates what percentage of a companys sales
revenue would remain after all costs have been taken into account. This is best compared with
other companies in the same industry and analyzed overtime. Considering that variations from
year to year may be due to abnormal condition to explain this further, a declining net profit margin
ratio may indicate a margin squeeze possibly due to increased competition or rising costs (Keiso,
2002).
Net profit Margin= 100
Return on assets: Return on assets, commonly referred to as ROA.Is a measurement of
management performance. ROA tells the investor how well a company uses its assets to generate
income. A higher ROA denotes a higher level of management performance. Arising ROA, for
instance may initially appear good, but turn out to be unimpressive of the companies in its industry
have been posting higher returns and greater improvements in ROA. The ROA ratio may thus be
more useful when compared to the risk free rate of return. Technically, a company should produce
on ROA higher than the risk free rate of return to be rewarded for the additional risk involved in
operating the business. If a companys ROA is equal or even less than free rate, investors should
think twice as they would be better off just purchasing a bond with guaranteed yield (Harrington,
1993).
Return on assets= 100
Return on equity (ROE): Return on equity, commonly referred as ROE. Is another measurement
of management performance.ROE tells the investor how well a company has used the capital from
its shareholders to generate profits. Similar to the ROA ratio; a higher ROE donates a higher level
Simplifies financial statements: ratio analysis provides data for inter-firm comprehension
of financial statements. Ratio tells the whole story of changes in financial condition of the business.
Facilitates inter-firm comparison: ratio analysis provides data for inter-firm comparison. Ratios
highlight the factors associated with successful firms. They also reveal strong firms and weak
firms, over valued firms. Makes intra-firm comparison possible: ratio analysis also makes
possible comparison of the performance of different division of the firm. The ratio is helpful in
deciding about their efficiency or otherwise in the past and likely performance in the future helps
in planning: Ratio analysis helps in planning and forecasting. Over a period of time a firm or
industry develops certain norms that may indicate future success or failure. If relationship changes
in firms data over different period may provide clues on trends and future problems. Thus ratios
can assist management in its functions of forecasting, planning, coordinating, controlling and
While ratio analysis is obviously a very useful technique for evaluating performance, it is
Comparative study required: Ratios are useful in judging the efficiency of the business only
when they are compared with the past result of the business or with the result of similar business.
However, such a comparison only provides a glimpse of the past performance and forecasts for
the future may not be correct since several other factors like market conditions, management
policies
Limitation of financial statements: Ratios are used only on the information which has been
recorded in the financial statements. Because financial statement suffer from a number of
limitations, the ratios derived there from, are therefore also subject to those limitations.
Inadequacy of ratios: Ratios are only indicators and hence they cannot be taken as final word
regarding good or bad financial position of the business. Otherwise variable also have to be
considered. For example a high current ratio does not necessarily mean that company has a good
liquid position in case current assets mostly comprise outdated stocks (Eugene, 2009).
Window dressing: The presence of particular ratio may not be a definite indicator of good or bad
management. For example, a high stock turnover ratio is generally considered to be indication of
operational efficiency of the business. But this might have been achieved by unwarranted price
reductions or failure to maintain proper stock of goods. Similarly the current ratio may be improved
just before the balance sheet date by postponing replenishment of inventory (Carcello, 2008).
Problems of price lever changes: Financial analysis based on accounting ratios will give
misleading results if the effects of changes in price levels are not taken into account. For instance,
two companies set up in different years, having plant and machinery of different ages, cannot be
compared, on the basis of traditional accounting statements. This is because the depreciation
charges on plant and machinery in case of the old company would be as much lower figures as
compared to the company that has been set up recently (Mark, 2008).
No foxed standards: No fixed standards can be laid down for ideal ratios. For example, current
ratio is generally considered to be ideal if current assets are twice the current liabilities. However,
in case of those entities which have adequate arrangements with their bankers for providing funds
when required, it may be perfectly ideal if current assets are equal to slightly more than current
Historical cost: As financial statements are normally prepared on historical costs basis, unadjusted
for inflation, the accounting amount are removed from economic value. This will be reflected by
the understatement of fixed assets and possibly inventory, while the value of long term debt will
decline in real terms. This results in equity being understated. These factors make ratio
comparisons overtime, for a given period less reliable than would be the case in the absence of
inflation. The above limitation does not negate the usefulness of ratio analysis but is important to
note that analysts should be aware of them and make necessary adjustments. It may therefore be
concluded that ratio analysis, if done mechanically, is not only misleading but also dangerous as
the effectiveness of the exercise depends upon the interpretation of the ratios and hence the skills
of the analyst. If an analyst appliers ratio analysis perceptively, ratios will provide useful insight
Business performance is a multidimensional concept. There are various indicators that can
for business performance management. It is a business management approach that entails aspects
of reviewing the overall business performance and determining how the business can better reach
its goals. These activities are aided by software tools, called BPM tools. BPM is often thought of
as a business strategy that enables businesses to efficiently collect, aggregate and analyze data
from various sources in order to take the most appropriate business action (Balon, 2010).
It enables businesses to: Improve productivity, Monitor and analyze business processes,
Automate tasks, Increase efficiency, Increase effectiveness, Financial viability, Identify cost
savings opportunities, Generate new business, Measure key performance objectives, Analyze
risks, Predict business outcomes. Business performance management requires the alignment of
strategic and operational objectives to the business activities in order to manage performance. By
collecting and analyzing data, business managers are more informed about the company's position
Foster, (1986) defined financial analysis as the process of identifying the financial strengths
and weaknesses of the firm by properly establishing relationship relationships between the items
of the balance sheet and profit and loss account. He father puts it that, financial analysis can be
undertaken by the management of the firm or by parties outside the firm, viz owners, creditors,
and investors. However the nature of the analysis will differ depending on the purpose of the
analyst.
Keown, (1979) defined financial analysis as one that involves the assessment of the firms
past, present and future financial condition. The objective is to identify any weaknesses in the
firms financial health that could lead to the future problems and determine the strength that firm
might capitalize upon. For example internally financial analysis might be aimed at assessing the
firms liquidity or measuring its past performance. Alternatively, from the outside, the firm might
be aiming to determine the firms credit worthiness or credit potential. However, regardless of the
Lawrence, (1992), asset that financial analysis and planning is concerned with transforming
financial data into a form that can be used to monitor the firms financial condition. These
functions encompass the entire balance sheet as well as the firms income statement and underlying
fundamental definition of any profit-seeking business is an entity that acquires resources in order
to generate profits through the production and sale of goods and/or services. Ratios show important
relationships between a firms resources and its financial flows. In a way, ratio analysis provides
a report card. If the firms managers are doing a good job, they know it. If they are not doing a
good job, not only will they know it, but they will also have a clear understanding of what they
A financial ratio is a number that expresses the value of one financial variable relative to
another. It is the numeric result gained by dividing one financial number by another. Calculated
this way, financial ratio allows an analyst to assess not only the absolute value of a relationship
but also to quantify the degree of change within the relationship (Lawder, 1989).
Financial ratios are said as the most widely used indicators of company. It play a role to
targets and to indicate the process of organizational in completing or the time needed to complete
The financial analysis model known as a quite helpful tool for executives to measure or
(authorities) with the possibility or hoping to avoid failures. Also it becomes an early warning
companies, between industries, between different time periods for one company, between a single
company and its industry average. Apart from that, financial ratios generally hold no meaning
unless they are benchmarked against something else, like past performance or another company
and industries. The reason behind that is the ratios of firms in different industries, which face
different risks, capital requirements, and competition are usually hard to compare if we have no
A study using financial ratios in the 1930s and several later studies were concerned with
business failure (Altman, 1971). It was ascertained that failing firms exhibited significantly
different ratio measurements than businesses which were successful. Historical accounts
specifically cite the use of ratios in predicting bankruptcy. Overall, the ratios which measure
profitability, liquidity, and solvency have prevailed as the most useful indicators for business.
According to Ketz, Doogar and Jensen (1990), financial ratio analysis is frequently used:
(a) to compare a present ratio with past and expected future ratios for the same company or firm,
and (b) to compare one firm with those of similar firms or with industry averages at some point in
time.
As stated by Darrel, (2011) the basics of financial analysis usually mean calculating
different financial ratios and then coming to conclusions and clarification regarding on how the
company is financially performing in business activities. There are certain things that must be
companys data. Must take into consideration all financial ratios numbers derived from financial
statement comprise of balance sheet and income statement. Balance sheets represent a reflection
for a particular point in time. Income statements represent a cumulative time summary of
performance. For example, year-end financial statements should include a balance sheet that
presents how various company accounts look on that particular day at the end of the year, whereas
the income statement shows how companys performance over the period (Osteryoung &
Constand ,1992).
Second is evaluating external influencing factors. As with all companies, the financial
statements can be influenced by various factors like management or owner decisions and
discretionary spending, seasonal effects, legal structure choice, type of industry, customer mix, or
a number of other issues. These factors can influence the financial statements and will, in turn,
Third is look at internal trends. Always keep in mind is that one ratio alone tells one very
little. A clear picture starts developing when one looks at ratios over different time increments. By
comparing financial results against prior performance one gets a better idea of what is occurring
within the company. Trends will start to develop and can give insight into areas that may need
corrective attention or to areas that may need to be reinforced. Internal trend analysis is most likely
most beneficial because one is comparing similar business situations over various periods of time
(Divine, 1995).
Fourth is compare results to the industry. Comparing your business performance to other
similar businesses is a common way to judge how well the business is doing. Even though this is
very common, there are limitations to doing so. First realize these comparative ratios represent an
average. Averages are simply that and most likely your business will vary somewhat. Next be sure
you are comparing your business to other businesses similar in asset size and sales volume. In
some cases there may be no suitable comparisons. Knowing what is the average for your industry
is important. The averages can serve as a general benchmark for your business. Additionally, these
averages are often times used to compare your business performance when you are seeking capital
from outside sources such as a bank. Being different may not be a deal killer, but not being able to
explain why you are different may indeed be a deal killer (Edmister, 1972).
These activities include the selection of business goals, consolidating measurable information
relevant to those goals, and the participation of management to assist in improving future
performance. This process involves the gathering of large amounts of data. Commonly most
organizations have difficulties taking the collected data and transforming it into useful information.
Also many companies are trying to gather information from different sectors of their organization
such as finance, inventory, forecasting, and human resources eliminating the need to use
As stated by Vince, (2003) BPM systems capture and disseminate strategic information
that matters most to the firm in the form of strategic process and outcome measurement, and most
to the individuals within the firm in the form of performance measurement, incentives and
motivation. Because of this, BPM systems are a primary means of knowing (coordinating what a
firm knows and learns) and doing (how it alters what it does). Over time, they may perhaps
become the single most strategic information system resource in the firm.
Kerssens, Drongelen & Fisscher, (2003) they observed that the Performance measurement
and reporting takes place at 2 levels: (1) company as a whole, reporting to external stakeholders,
(2) within the company, between managers and their subordinates. At both levels there are 3 types
of actors: (a) evaluators (e.g. managers, external stakeholders), (b) evaluatee (e.g. middle
managers, company), (c) assessor, which is the person or institution assessing the effectiveness
and efficiency of performance measurement and reporting process and its outputs (e.g. controllers,
to be made and actions to be taken because it quantifies the efficiency and effectiveness of past
actions through the acquisition, collation, sorting, analysis, interpretation, and dissemination of
appropriate data. Organizations measure their performance in order to check their position (as a
their position (as a means to communicate performance internally and with the regulator), confirm
priorities (as a means to manage performance, cost and control, focus investment and actions), and
The study of Abdallah, (2008) aimed to identify whether the Jordanian industrial
companies applied the modern management accounting and to identify the most important benefits
the companies get from these methods. The results of the study showed that the most important
benefits of applying these methods is providing the administrations with the appropriate
information in appropriate time, improving the products quality and reducing the costs.
As observed by Lionel, (1987) in his paper entitled: The Farmer's Cooperative Yardstick:
Financial Ratios Useful to Agricultural Cooperatives, he found that Sound financial planning and
management are two key elements to the successful operation of cooperatives. Sound financing
relates to the need for both equity and borrowed capital for operations and growth. It also involves
the analysis of financial data to develop financial controls. Cooperative management should find
As stated by Karacaer and Kapusuzolu, (2008) in their paper entitled: An Analysis of the
Effect of Financial Ratios on Financial Situation of Turkish Enterprises, they found that the most
highest ratios contribution in the analysis regarding them variables whose effect the financial
condition of the sample enterprise are ROE, debt ratio, net working capital, acid test ratio, net
profit ratio, cash ratio, and current ratio respectively. Among of them, the liquidity ratios are the
main element in these ratios. It is observed that all the variables have differing but significant
Thachappilly (2009), in this articles he discuss about the Financial Ratio Analysis for
Performance evaluation. It analysis is typically done to make sense of the massive amount of
numbers presented in company financial statements. It helps evaluate the performance of a
company, so that investors can decide whether to invest in that company. Here we are looking at
the different ratio categories in separate articles on different aspects of performance such as
profitability ratios, liquidity ratios, debt ratios, performance ratios, investment evaluation ratios.
Clausen (2009), He state that the Profitability Ratio Analysis of Income Statement and
Balance Sheet Ratio analysis of the income statement and balance sheet are used to measure
company profit performance. He said the learn ratio analyses of the income statement and balance
sheet. The income statement and balance sheet are two important reports that show the profit and
net worth of the company. It analyses shows how the well the company is doing in terms of profits
compared to sales. He also shows how well the assets are performing in terms of generating
revenue. He defines the income statement shows the net profit of the company by subtracting
expenses from gross profit (sales cost of goods sold). Furthermore, the balance sheet lists the
value of the assets, as well as liabilities. In simple terms, the main function of the balance sheet is
to show the companys net worth by subtracting liabilities from assets. He said that the balance
sheet does not report profits, theres an important relationship between assets and profit. The
White (2008), He refer that the accounts receivable is an important analytical tool for
measuring the efficiency of receivables operations is the accounts receivable turnover ratio. Many
companies sell goods or services on account. This means that a customer purchases goods or
services from a company but does not pay for them at the time of purchase. Payment is usually
due within a short period of time, ranging from a few days to a year. These transactions appear on
Jenkins (2009), Understanding the use of various financial ratios and techniques can help
in gaining a more complete picture of a company's financial outlook. He thinks the most important
thing is fixed cost and variable cost. Fixed costs are those costs that are always present, regardless
of how much or how little is sold. Some examples of fixed costs include rent, insurance and
salaries. Variable costs are the costs that increase or decrease in ratios proportion to sales.
As mentioned by Salmi, Timo, Dahlstedt, Martti & Laakkonen (1988), financial ratios are
commonly used for comparison of financial position intra-industry. Also, in financial statement
analysis a firm's performance and financial status are frequently evaluated in relation to other firms
Jagetia has given an article in the journal Management Accountant March, 1996 on the
subject, Ratio Analysis in Evaluation of Financial Health of a Company:. The main objective of
this article was that the ratio analysis is often under-rated but extremely helpful in providing
valuable insight into a companys financial picture. He observed that the ratios normally pinpoint
business strengths and weakness in two ways-Ratios provide an easy way to compare todays
performance with the past. Ratios depict the areas in which a particular business is competitively
advantageous or disadvantageous through comparing ratios to those of other business of the same
size within the same industry. He concluded that the ratio analysis should not be viewed as an end
but should be viewed as a starting point. Ratios by themselves do not answer the questions. One
must look at other sources of data in order to make a judgment about the future of the company.
Forza & Salvador, (2000), in the International Journal of Operations & Production
Management, Vol. 20, No. 3, pp. 359-385 entitled: Assessing Some Distinctive Dimensions of
Performance Feedback Information in High Performing Plants, they concluded that a performance
management process mainly fulfilling two primary functions: the first one consists in enabling and
structuring communication between all the organizational units (individuals, teams, processes,
functions, etc.) involved in the process of target setting. The second one is that of collecting,
Ittner, Larcker & Randall , (2003),in their paper entitled: Strategic performance of a firm,
they observed that a strategic performance measurement system: (1) provides information that
allows the firm to identify the strategies offering the highest potential for achieving the firms
objectives, and (2) aligns management processes, such as target setting, decision-making, and
Maisel, (2001).In his book entitled: Performance Measurement Practices Survey Results,
he concluded that a BPM system enables an enterprise to plan, measure, and control its
performance and helps ensure that sales and marketing initiatives, operating practices, information
technology resources, business decision, and peoples activities are aligned with business