Examining the usefulness of Financial Statement Analysis

Examining the service equalness of monetary Statement AnalysisFinancial tale digest involves the assessment of a condescensions olden, present and future condition. The accusative is to identify the weaknesses as healthy as the strengths of a business. If weaknesses argon install, the business faecal matter defend book steps to correct or all overcome them. On the other(a) hand, the business nookie use its strengths to its advantage. In this delegacy, the business will be able to improve its overall pecuniary situation in the future. As the business owners they ar intently interested in how well their business is doing. The to the highest degree bidly way to determine the status of a business is by analyzing the pecuniary data and that means crunching the numbers.The basics of fiscal compendium normally mean collusive diverse pecuniary proportionalitys and then coming to conclusions more or less the how the community is pecuniaryly performing. Financial balances here refer to principal pawns for financial analysis as they can be apply to answer numerous questions regarding the businesss financial well cosmos. Financial ratios are used by trey main groups. runner is Managers, who employ ratios to process fail, control, and thus improve their steadfasts operations. Second is a credit analyst, such(prenominal) as bank loan officers or bond rating analysts, who analyze ratios to help ascertain a corporations efficacy to fee its debts. triplet is stock analyst, who is interested in a conjunctions efficiency, risk, and growth prospects. likewise, the ratios deliver usable information to users of financial affirmations for example investors and analysts to assess and evaluate the operations undertaken as well as being used to analyze its doing and built in bed over time (Al-Ajmi J., 2008). As stated by Al-Ajmi J. (2008), the most eventful of the users groups to know about financial ratio analysis are investors and cr editors be example these users interested to read the limit of financial rumors and calculate a variety of financial indicators before they want to make each concluding decisions on credit and investing decisions. To them, they believe that through and through analyzing financial statement will provide worth(predicate) financial indicators and stick out predictive power. Financial analysis can be make through assessing the financial statement of company. Financial statement in this case focuses on balance sheet, income statement, cash flow statement and statement of changes in equity.Financial ratios are generally classified into four main groups fluidness ratios, legal action ratios, gearing ratios, and positivity ratios. The liquidity ratios can be used to mea sure as shooting whether the sign can get its financial obligations on time or not. The two commonly used liquidity ratios are the place of flow ratio and the alert ratio. Next is activity ratios can be used t o measure how effectively the firm uses its resources ( as fix ups) to generate sales or revenue. This ratio is so called efficiency, turnover or even business as cross out heed ratios. Commonly used to measure activity ratios are inventory turnover ratio, modal(a) allurement compass point, accounts receivable turnover ratio, non-current assets turnover ratio and total assets turnover ratio. Third is gearing ratios as well as called debt management ratios and leverage ratios. This ratio indicate how the firm is utilizing outside stores to finance its assets and whether the firm can pay the interest on the use of these non-owner supplied funds as well as repay the principal or the original amount of the loan. Commonly used to measure gearing ratios are debt ratio, time interest clear ratio and debt to equity ratio. Lastly are profitability ratios which can measure the end results of the firms ability to ready profits from its resources as well as to measure the companys use o f its assets and control of its expenses to generate an acceptable rate of return. The most commonly used ratio is gross profit margin and net profit margin. intimate the financial ratios of our business is heavy because by knowing what these ratios mean and being aware of trends can caution the entrepreneur in cave in managing a business in future.In general this paper is reviewing the literary works review on the effect of analysis of financial ratios on business financial process or financial situation in three contrary types of industries. Focus on the analysis of financial ratio in service constancy, financial labor and high(prenominal) substructureal pedagogy. There are unlike views and diverse personal effects when financial ratio analysis going to used to analyze company proceeding from different types of industry.LITERATURE REVIEW2.1 USEFULNESS OF FINANCIAL RATIOSFinancial ratios are express as the most astray used indicators of company. It play a single- p rotectd function to value firms, to distinguish creditworthy companies correspond to others, to identify erudition targets and to indicate the process of organizational in completing or the time needed to complete a task (Al-Ajmi J., 2008).The financial analysis model cognize as a quite helpful as welll for executives to measure or predict enterprise bankruptcy or enterprise failure provides concerned decision-makers (authorities) with the casualty or hoping to avoid failures. Also it becomes an early warning system to the corporate management. (Karacaer and Kapusuzolu, 2008).As stated by Karacaer and Kapusuzolu, (2008), the most highest ratios contribution in the analysis regarding the 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 leverively. Among of them, the liquidity ratios are the main element in these ratios. It is observed that all the var iables have differing but significant effects on the corporate financial situation.Financial ratios can be used as financial indicators which lay off for comparisons between 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 equation if we have no other things to compare (Wikipedia).As mentioned by Salmi, Timo Roy Dahlstedt Martti Luoma Arto Laakkonen (1988), financial ratios are commonly used for comparison of financial position intra-industry. Also, in financial statement analysis a firms performance and financial status are often evaluated in relation to other firms in the sa me branch of industry or in relation to industry averages.2.2 STEPS TO centerIVELY FINANCIAL RATIOSAs stated by Darrel Hulsey, 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 considered before too many conclusions are drawn.Firstly, understand what comprise different financial ratios before start analyzing companys data. Must take into consideration all financial ratios numbers derived from financial statement comprise of balance sheet and income statement. correspondence sheets support a reflection for a particular proposition point in time. Income statements present a cumulative time nubblemary 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 periodSecond 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, influence the financial ratios analysis.Third is look at internal trends. Always keep in mind is that one ratio completely tells one very little. A clear picture starts developing when one looks at ratios over different time increments. By canvas financial results against prior performance one gets a improve nous of what is occurring within the company. Trends will start to develop and can give insight into areas that may need disciplinal attention or to areas that may need to be reinforced. Internal trend analysis is most seeming most beneficial because one is comparing similar business situations over various periods of time.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 proportional 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. Try to insure you are comparing apples to apples. There are several sources to get comparative financial data including private companies such as Risk Management Association (RMA) and trade associations that collect data from their members. Knowing what is the average for your industry is important. The averages can serve as a general benchmark for your business. Additional ly, these averages are often times used to compare your business performance when you are seeking capital from outside sources such as a bank. be different may not be a deal killer, but not being able to explain why you are different may indeed be a deal killer.2.3 THE EFFECT OF ANALYSIS OF FINANCIAL RATIOS ON BUSINESS FINANCIAL SITUATION IN DIFFERENT INDUSTRIES2.3.1 SERVICE diligenceIn measuring the performance of service firms, the most strongest and consistent ratios used are activity and profitability ratios. Obviously, the profitability ratios indicate that small service firms have higher returns to sales than large firms. Specifically, service firms have less liquidity, greater activity, and higher profitability. Interestingly, the small and medium size service firms had higher total debt levels. The short debt findings show that service firms used significantly smaller amounts of short term funding. Means that service industry more prefer to finance the business activity t hrough long term debt. On straighten out of that in service industry, the most suitable of ratio to measure business profitability is by calculating return on equity. Apart from that, activity ratio was measured by a primary ratio and a secondary ratio. It refers to sales to assets and sales to inventory respectively (Michael D., derriere X. and Steven J.). The results found by Michael D., John X. and Steven J. associated with the activity ratios for service firms show a positive and significant relationship an concluded that size of firm very unrelated to productivity of creation firms in service vault of heavenThe growth in production line transportation industry gives a picture that performance evaluation is important for executives body to identify and clear the operating problems arise in commercialise competition. According to Feng C.M. and Wang R.T. (2000), referring to previous study it more concerning air duct performance evaluation which only focus merely on operat ional performance. However, evaluation on financial performance is seems to be ignored. As far as we are concern, to measure the survival prospect of an airway commercialize can be look through the financial performance of the company itself. The absence of financial ratios may lead to biased assessment.There are three main types of performance indicators used in airline industry. The first one is production efficiency, merchandise efficiency and execution efficiency which relate to department of production, marketing and management (Feng C.M. and Wang R.T., 2000).As stated by Feng C.M. and Wang R.T. (2000), in making analysis of financial statement of airline industry, assets and capital of the owners equity are classified as the input of financial factors. Moreover debts and expense are classified as the output of the financial factors and for revenue or otherwise losses categorized as the outcome of financial factors. Due to that, the input financial factors characterized by s unk cost which included public life equipment and interest expense, while its output by intangible products. Otherwise its consumption characterized as not-stored services.2.3.2 FINANCIAL INSTITUTIONSEvaluating the performance and financial condition of the financial service organizations is very critical. The intermediation role of financial institutions in market trading is such that performance in this sector indirectly gives impacts on other sectors of the economy. When performance is nigh it will contribute a positive effect on the economy but when the financial sector is distressed and got some problems then they will contribute a negative effect on other sectors of the economy (Ibiwoye A., 2010).In the perspective of banks to achieve their aims for institution development was by growing the components of their assets as an alternative of moving to increase the profitability. All of these require the determination and management of several factors, which play an important r ole in the profitability of banks in the new environment (Halkos and Salamouris 2004).In U.S Banks, to increase investors hope and confidence, they adopt rule Bond Rating Service (DBRS) which provides bank ratings as a forward-looking measure of a banks ability to congruous its financial obligations. The DBRS ratio analysis focuses on four interrelated aspects of a banks financial health. First is Earnings Power, it refers to the ability to generate consistent profits and grow capital internally. Second is Asset Quality, it refers to the effectiveness for losses that could impair earnings and capital. Third is liquidity where it focuses on cash resources available to meet short obligations. And the last one is Capital Adequacy it refers to the ultimate creditor protection against future losses (Reid, Lister, Schwartz, and Muranyi, 2005)According to Al-Ajmi J., (2008), the financial indicators that analysts use as basis for decisions are not necessarily all equally useful to them in making any decision. There are no significant differences between credit analysts and financial analysts with respect to 40 of the indicators identified in the study. From the perspectives of 244 credit analysts and financial analysts in Bahrain, they are measured by the be of 71 financial indicators and 5 components of corporate governance. ground on the result it shows that credit analysts consider the quick ratio as the most useful ratio, followed by the non-recurrent ratio. For the financial analysts they consider price-earnings as the most useful ratio, followed by the market-to-book ratio.It is also worth mentioning that the efficiency difference between large and small banks reaches its maximum value in 1999. While doing financial analysis it has a positive relationship between size and performance. Besides, through mergers and acquisitions it leads to a continuous increase of average efficiency of the larger banks while efficiency of the small banks is impaired. It is prove that the higher the size of total assets leads to the higher of the efficiency is. It is evidenced from the significant increase in the sum of the total assets employed in the market as well as the increase in the average level of Banks Assets (Halkos and Salamouris, 2004).2.4.3 HIGHER EDUCATION INSTITUTIONSAs study did by Buddy N.J. (1999), it identified a set of financial ratios that summarize the financial situation of a higher education institution in which the ratios helped to analyze the financial solvency and viability of the six higher education institutions in Oklahoma. The study focused on the ability of the institutions to meet current and future financial requirements of the institutions. Therefore financial ratio analysis is the most suitable and know as an effective communication to the mind of users regarding financial situations of universities and colleges to internal and external entities. On top of that, ratios known as excellent tools for facilitating the communication, analysis, and understanding of large masses of complicated, detailed information of the institutions.As what have been found in study conducted by Chabotar, (1989) Cirtin Lightfoot, (1996), they concluded that financial ratio analysis could also serve as a tool to evaluate the efficiency, effectiveness and accountability of higher institution education as what been done by ratio analysis in analyzing business financial condition. In this case Buddy N.J. (1999) s aid that financial ratio analysis allows for the evaluation of past performance and for future planning of institutions. By identifying a manageable number of quality ratios, the presentation of financial data may be more cost-efficient and tell a better story and give a better picture of the true financial condition of the institution of higher education. The reduction of a large mass of numbers into a a couple of(prenominal) manageable, easily interpreted ratios will allow both internal and external entit ies to make better-informed decisions regarding financial position and condition of higher learning institutions.In the opinion of Buddy N.J. (1999), understanding the financial condition of higher education institutions become an important part in view of decision making to respond to any pressures arise. As supported by Chabotar, (1989) where work on financial ratio analysis for higher education institutions has aimed at clarifying and explain the perceptions and making judgments of financial distress more credible. Financial ratios can also have the reverse use, to identify what is unique about a higher education institution. The most frequently cited motivation for financial ratio analysis is the ability to control for the effects of size difference over time and across institutionsAs mentioned by Buddy N.J. (1999), financial ratio analysis can help both the institutional user and those agencies to make funding decisions. This is due to where the financial ratio analysis could b e used to obtain the physical evidence of any deviations of the norms and could also allow management by exception. Also financial ratios recognized as an indicator to whether conditions are getting worse or getting better which may allow management by exception and alerts the institution to the possibility of future financial distress. Besides, financial ratio analyses have a role to identify how and in what ways the condition is changing (Collier Patrick, 1978).Lupton, Augenblick, and Heyison (1976) in their study identified the indicators which include institutional control, enrollment trends, trends in education and general expenditures, current fund revenues to expenditures, academic expenditures to education and general expenditures, freshman full-time equivalents (FTEs) to total undergraduate FTEs, and tuition and fees to student aid revenues. All these indicators determined by using a panel of experts, as well as break analysis, to determine 16 discriminating indicators of financial condition.Whereas, Collier and Patrick (1978) conducted theory-based research and developed a set of dimensions that describe financial condition which comprise of financial independence, revenue drawing power, financial risk, revenue stability, and seize strength. Same as what being done by Lupton etc., Collier and Patrick also used experts and discriminate analysis to determine the indicators that differentiate between strong and weak private institutions and between strong and weak public institutions. As agreed by Buddy N.J. (1999) the purpose of institutional comparisons is to highlight differences and to raise important questions about past and future policies for internal and external entities. The reason is many higher education institutions differ from comparative peers for good and valid reasons. The argument might be that, when an understanding is reached for why an institution scores otherwise from its comparative peers, a conclusion can be drawn as to what is unique about that institution as compared to others institutions.Referring to study of Buddy N.J. (1999), he found that many of the measures financial ratios used by higher education institutions are based on what sources financial revenues are earned and for what services expenses are incurred. Based on the result it allows both internal and external entities to monitor institutional effectiveness and efficiency. There are 15 key financial relationships being used by Donald E. Miller (1972) to set forth for business and industry a cause-and-effect ratio analysis based. The reason is higher education institutions will find themselves in a particular financial position because of some cause or causes. The 15 ratios have been utilize and tested as a unified system in thousands of business situations demonstrated that, when used together provide a fundamental financial understanding to the users. The interrelationships that exist among financial resources require a better examinat ion of the institutions total fund structure. A better understanding of the trends in and the condition of the financial resources is important to the early detection of any institutional distress. Changes in resources are symptoms of those internal and external factors might cause financial pressure or development. A higher education institution with sufficient financial resources can withstand adverse trends and has the flexibility to institute changes at opportune moments to reverse the trends. Resources merely provide the chance to be flexible through economic changes and experiment where possible without jeopardizing and impair the institutions future prospect.3.0 CONCLUSIONIt is important to analyze trends in ratios as well as their absolute levels. Trend analysis can provide clues as to whether the firms financial situation is likely to improve or to deteriorate. Financial statement analysis involves a study of the relationships between income statement and balance sheet acc ounts, how these relationships change over time (trend analysis), and how a particular firm compares with other firms in its industry as we called as benchmarking. In addition, financial statements are used to help predict the firms future earnings and dividends. From an investors standpoint, predicting the future is what financial statement analysis is all about. From managements standpoint, financial statement analysis is useful both to help anticipate future conditions and, more important, as a starting point for planning actions that will influence the future course of eventsThe importance of financial statement analysis should not be underestimated. The understandable format of financial ratios allows virtually any stakeholder and users of financial statement to acquire a basic comprehension of the most critical financial policies of institutions and their financial condition.Chabotar, K. J. (1989). Financial ratio analysis comes to nonprofits. Journal ofHigher Education, 60(2) , 188-208. (ERIC chronicle Reproduction Service No. EJ 389089)Cirtin, A., Lightfoot, C. (1996). Financial statement analysis for privatecolleges and universities. The topic Public Accountant, 41(8), 29-34.Collier, D. J., Patrick, C. (1978). A multi-variate approach to the analysis ofinstitutional financial condition. Boulder, CO National Center for Higher EducationManagement Systems.Chabotar, K. J. (1989). Financial ratio analysis comes to nonprofits. Journal ofHigher Education, 60(2), 188-208. (ERIC Document Reproduction Service No. EJ 389089)Lupton, A. H., Augenblick, J., Heyison, J. (1976). A special report Thefinancial state of higher education. Change, 8(8), 20-35.Miller, D. E. (1972). The purposeful interpretation of financial statements Thecause-and-effect ratio approach. New York, NY American Management Association, Inc.