EFFECT OF FINANCIAL ANALYSIS ON INVESTMENT DECISION IN A MANUFACTURING COMPANY

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CHAPTER ONE

INTRODUCTION

  • BACKGROUND OF STUDY

Financial Statement Analysis is a method of reviewing and analyzing a company’s accounting reports (financial statements) in order to gauge its past, present or projected future performance. This process of reviewing the financial statements allows for better economic decision making.

Globally, publicly listed companies are required by law to file their financial statements with the relevant authorities. For example, publicly listed firms in America are required to submit their financial statements to the Securities and Exchange Commission (SEC). Firms are also obligated to provide their financial statements in the annual report that they share with their stakeholders. As financial statements are prepared in order to meet requirements, the second step in the process is to analyze them effectively so that future profitability and cash flows canbe forecasted.Therefore, the main purpose of financial statement analysis is to utilize information about the past performance of the company in order to predict how it will fare in the future. Another important purpose of the analysis of financial statements is to identify potential problem areas and troubleshoot those problems.

There are different users of financial statement analysis. These can be classified into internal and external users. Internal users refer to the management of the company who analyzes financial statements in order to make decisions related to the operations of the company. On the other hand, external users do not necessarily belong to the company but still hold some sort of financial interest. These include owners, investors, creditors, government, employees, customers, and the general public.The managers of the company use their financial statement analysis to make intelligent decisions about their performance. For instance, they may determine cost per distribution channel, or how much cash they have left, from their accounting reports and make decisions from these analysis results.

Small business owners need financial information from their operations to determine whether the business is profitable. It helps in making decisions like whether to continue operating the business, whether to improve business strategies or whether to give up on the business altogether.

People who have purchased stock or shares in a company need financial information to analyze the way the company is performing. They use financial statement analysis to determine what to do with their investments in the company. So depending on how the company is doing, they will either hold onto their stock, sell it or buy more.

Creditors are interested in knowing if a company will be able to honor its payments as they become due. They use cash flow analysis of the company’s accounting records to measure the company’s liquidity, or its ability to make short-term payments.

Governing and regulating bodies of the state look at financial statement analysis to determine how the economy is performing in general so they can plan their financial and industrial policies. Tax authorities also analyze a company’s statements to calculate the tax burden that the company has to pay. Employees need to know if their employment is secure and if there is a possibility of a pay raise. They want to be abreast of their company’s profitability and stability. Employees may also be interested in knowing the company’s financial position to see whether there may be plans for expansion and hence, career prospects for them. Customers need to know about the ability of the company to service its clients into the future. The need to know about the company’s stability of operations is heightened if the customer (i.e. a distributor or procurer of specialized products) is dependent wholly on the company for its supplies.

Anyone in the general public, like students, analysts and researchers, may be interested in using a company’s financial statement analysis. They may wish to evaluate the effects of the firm on the environment, or the economy or even the local community. For instance, if the company is running corporate social responsibility programs for improving the community, the public may want to be aware of the future operations of the company.

Analysis of financial statement is meant to be comprehensive and relevant just to mention a few. To ensure that this is the case, there are two methods of financial analysis; the horizontal analysis, vertical analysis trend analysis, ratio analysis.

  • STATEMENT OF PROBLEM

Manufacturing companies have a nature that requires a great deal of record keeping based on accounting principles and the ever changing accounting standards. It is clear that proper analyses of financial statement are important in any organization. Nevertheless, one can not dispute the fact that with each method of analysis there is an underlying factor that hinders the comparability of records.Thus, the problem at hand is the scheme of window dressing which an investor has to be on the lookout for If he wants to make a good investment decision. Window dressing is referred to as cosmetic financial reporting or creative accounting. It is a situation whereby the financial statements are reported to deliberately or intentionally falsify the accounts with the aim of overstating the performance of a business. This could mislead a potential investor into a non profitable investment decision. Proper financial analysis will open the eye of not just the investor but also other users of such information. They will be able to detect the loopholes and see a misleading financial statement for what it is.

This study aims at explaining the effects of financial statement analysis on investment decision making in manufacturing industries. With that being said, it is befitting to say that anything outside from a proper financial statement is a problem to investors and users of accounting information. Thus window dressing aims at destroying the essence of a proper financial statement, thereby making room for unprofitable or unfavorable investment decision making.

  • OBJECTIVE OF STUDY

The broad objective of his study is to analyze the effect of financial analysis on investment decision.

Specific objectives are to;

EFFECT OF FINANCIAL ANALYSIS ON INVESTMENT DECISION IN A MANUFACTURING COMPANY