Guiding Investment Decisions: Importance Of Analyzing Financial Statements

Literature review

Discuss about the Guiding Investment Decisions.

Financial statements are the most important documents for a business organization. Financial statements help the stakeholders understanding the financial position of the company in a particular period of time. This means the financial statements of a company help its stakeholders taking their decision regarding investments or any other purposes. Hales, Rees and Wilks (2016) stated that the financial statements of the companies not only provide the past financial overview of the company, but it also helps understanding the future capability or possibility of the companies in context to the financial performance.

However, Collis et al., (2016) argued that only the review of financial statements is not enough for taking any investment decision or other decisions because there are many other non-financial attributes that must be analyzed. In support of this, Fontes, Rodrigues and Craig, (2016) stated that many times companies misstate their financial performance in their financial statements and due to this, the stakeholders do not completely depend on the financial statements while taking any particular decision. On the contrary, Donelson, Jennings and McInnis (2016) noted that without checking the financial statements no one can understand the current financial or market position of the company. Hence, while taking any decision, analyzing the financial statements is essential. Therefore, it can be said that there are different views regarding the usefulness of the financial statements of the companies.

The aim of this particular study will be analyzing the importance or usefulness of the financial statements for the purpose of performance standard measurement of the companies and guiding the stakeholders in taking investment decision. In order to make the study more concise, the focus will be made mainly on the financial statements of Woolworths Limited and Wesfarmers Limited in Australia. There are two variables in this research topic, one is dependent and the other is independent. The independent variable is the financial statements and the dependent variable is the performance standard of the companies.

Background of the research topic:

Discussing how the financial statements help measuring the performance standards of the companies

According to Hutadjulu and Blesia (2016), financial statements are the official documents or records that disclose the financial activities of the companies during a particular period of time. Financial statements are prepared for a specific period of time. The companies can prepare the financial statements quarterly, half-yearly or annually. Berger, Minnis and Sutherland (2016) mentioned that according to different accounting standards like, AASB, IASB or GAAP, preparing the financial statements is essential for every company. On the other side, Dung (2016) noted that preparing the financial statements is not only important for measuring the financial performance or position of a particular company, but it also helps comparing the financial performances of two or more companies in a specific period of time. Below, the comparison of the financial performances by using the financial statements of Woolworths Limited and Wesfarmers Limited are shown:

Research questions

Woolworths Limited:

Financial Ratios	2014	2015
Gross margin	38.79932	39.86637
Net margin	7.48548	5.372918
Current ratio	1.050601	0.9081
Quick ratio	0.794164	0.260841
Assets turnover ratio	1.793704	1.400772
Debt to equity	0.664413	0.538505
EPS	350.6	337.3

Table 1: Financial ratios of Woolworths Limited

(Source: Woolworthsgroup.com.au, 2017)

Wesfarmers Limited:

Financial Ratios	2,014	2,015
Gross margin	4.644323	6.019505
Net margin	4.468188	3.907313
Current ratio	1.131486	0.934917
Quick ratio	0.483048	0.369731
Assets turnover ratio	1.514864	1.545641
Debt to equity	0.20845	0.232476
EPS	234.6	216.1

Table 2: Financial ratios of Wesfarmers Limited

(Source: Wesfarmers.com.au, 2017)

The above two tables are disclosing the financial positions of Woolworths Limited and Wesfarmers Limited for the two financial years that are 2015 and 2014. The tables are showing the financial ratios of the two companies, which are calculated by considering financial figures mentioned in the financial statements like, income statements and balance sheet statements of the companies. Therefore, analyzing the financial ratios is same as analyzing the financial statements of the companies.

The above two tables of two different companies are clearly showing that the profitability of the Woolworths Limited in 2014 and 2015 was much better than that of Wesfarmers Limited. This is because the gross margin and net margin of Woolworths Limited were better than the Wesfarmers Limited. On the other side, if the current ratio and quick ratios of the companies for these two years are considered, then it can be understood that the liquidity position was also good at Woolworths Limited than the liquidity position of Wesfarmers Limited (Prentice, 2016). The debts to equity ratios are disclosing the capital structure of the companies.

Analyzing the debt-to-equity ratios it can be said that in the capital structure of Woolworths Limited, the use of debt capital was more than the equity capital (O’Hare, 2016). However, in case of the Wesfarmers Limited, the use of equity capital was more than the debt capital in the capital structure of the company. This indicates that the capital structure of Woolworths Limited is riskier than the capital structure of Wesfarmers Limited (Perri & Shuli, 2016). On the other side, if the earnings per share of the companies are compared then it can be identified that the performance of Woolworths Limited was better than the Wesfarmers Limited because the EPS of Woolworths limited in 2014 and 2015 was better than Wesfarmers Limited.

Therefore, from the above discussion, it is clear that the Woolworths Limited was better performer than the Wesfarmers Limited during 2014 and 2015. The performance standards of the two companies are cleared out by calculating the ratios from the data available in the financial statements of the companies. Hence, it is obvious that the performances of the companies are measured by analyzing the financial statements of them.

While taking the investment decisions, the investors always analyzes the financial capacity of the companies (Karwowski, 2016). The financial capacities of the business organizations can be better understood by analyzing the financial statements of the companies. For example, an investor wants to invest the funds either in Woolworths Limited or in Wesfarmers Limited. However, before investing the funds in the businesses, the investor will verify the capability of the companies providing high return to the investment and the investor will also compare the financial capacities of the two organizations (Guay, Samuels & Taylor, 2016). Now, in order to take the decision, the investor will verify few specific financial facts like, cash inflows during last few years, assets values of the companies, revenues of the companies, net profits of the companies and the cost structures of the companies. All of these financial facts of the two companies will be available in the financial statements. This means, in order to take the final investment decision, the investor will verify or analyze the financial statements of Woolworths Limited and Wesfarmers Limited (Kim et al., 2016). Hence, it can be said that the financial statements help the external investors taking the investment decisions.

On the other side, if this matter is discussed from the point of view of the managements of the companies, then also it can be said that the financial statements are important for taking investment decisions (Uwuigbe et al., 2016). For example, the management of Woolworths Limited is planning to invest some funds into a particular project. In order to take this particular decision, the management will identify and analyze the net present value of the investment and to identify the net present value, the management will require the future cash inflows. This means, for the management of the companies, the financial statements are also very important.

This research will be directed to identify the answers of the following research questions:

• Why the stakeholders use the financial statements to measure the performance standard of the companies?
• What are the limitations of using the financial statements while measuring the performance standards of the companies?
• How far the financial statements of Woolworths Limited and Wesfarmers Limited are useful to their stakeholders?
• How the stakeholders can utilize the financial statements in a better way?

The financial statements are not sufficient enough for measuring the financial performance of the companies and taking investment decisions.

The financial statements are sufficient enough for measuring the financial performance of the companies and taking investment decisions.

Methodology is very important part of a research, on which the success of the research depends (Vaioleti, 2016). This particular study also will also follow such a methodology, which will be most appropriate for the research. The methodology of a research project includes mainly three elements – research philosophy, research approach and research design. Three alternative philosophies are there, which can be used for conducting a research project effectively and these are – positivism philosophy, interpretivism philosophy and realism philosophy. However, this research project will follow the positivism philosophy of research. The positivism research philosophy will be selected because this research philosophy is very effective in analyzing the research data in quantitative manner (Silverman, 2016). Quantitative analysis on the other hand helps understanding the research findings easily. Therefore, the use of positivism philosophy will help conducting the study and identifying the results in a better way (Marais & Pienaar-Marais, 2016).

A research can follow either of the two available research approaches – deductive research approach and inductive research approach. In case of the research approach, the study will follow the deductive research approach. The deductive research approach will be selected for this research because this approach is less time consuming. As the study will have very limited time span, the deductive approach will help completing the study within the short time. At the same time, the deductive research approach is very simple to understand and follow (Simonsohn, Nelson & Simmons, 2017). There are mainly three different research designs are available and these are – descriptive research design, explanatory research design and exploratory research design. In case of the research design, the study will follow the descriptive research design. The primary reason for selecting the descriptive research design is that the descriptive research design helps analyzing the research data in detail manner. This research design will help the study conducting the qualitative research based on the existing literatures and theories.

Project plan

Activities

Week 1

Week 2

Week 3

Week 4

Week 5

Week 6

Week 7

Week 8

Week 9

Week 10

Week 11

Week 12

Week 13

Week 14

Topic selection

Setting aim, objectives, questions and hypotheses

Conducting literature review

Setting research methodology

Data collection

Data analysis

Findings

Conclusion

Recommendations

Preparing final draft

Table 1: Gantt chart

This research project will follow a systematic process so that the study can achieve its goal easily. The process of the research will start by selecting the topic of the research. While selecting the research topic, the variables of the research will be identified clearly. After selecting the research topic, the aim and objectives of the research will be set. At the same time, the research will also set the questions and hypotheses. After setting the questions of the research and hypotheses of the research, the study will next start the literature review by considering the questions and objectives of the study. The literature review will take much time because during the literature review, the study will analyze the existing literature and related theories. This will be the secondary data for the study.

After conducting the literature review, the study will select the proper methodology for collecting and analyzing the data from different sources. After selecting the methodology, the study will focus on the data collection process and after data collection; the data analysis will be started. The results from the data analysis will be the findings of the research and then the research will verify whether the findings are able to meet the research objectives and answer the research questions or not. Then the study will arrive at conclusion and after that the research will provide some recommendations. After all of these works, the final draft will be prepared.

This study will include both primary as well as secondary data. The primary data for the research will be collected through the survey and interview methods. The survey will be conducted with the investors of Woolworths Limited and Wesfarmers Limited. The survey will be done through social media like, Gmail. The survey form will be sent to 100 investors of both the companies and it can be expected that 70 will be agreed taking part in survey. The sample for the survey will be selected through probability sampling method because the number of investors of these two companies will be huge. On the other side, the interview will be taken from the managers at Woolworths and Wesfarmers. The sample size for the interview will be selected through the non-probability sampling technique because the number of managers in these two organizations is less. The secondary data for this research will be collected from different journals, articles and websites.

In order to analyze the research data properly, the study will use the quantitative as well as qualitative data analysis methods. Quantitative method is the scientific analytical method that provides the findings or results in numerical form (Wiek & Lang, 2016). On the other side, qualitative method provides the research findings in theoretical format. In this particular study, the survey data will be analyzed through the quantitative data analysis method and the interview data will be analyzed through qualitative method.

This research project may face some limitations while collecting the research data and conducting the study. The main limitation that the study may face is the time limitation. The available time for this research will be very less and conducting the whole research properly within the limited time span may create difficulties. Another limitation that the study may face is the cost limitation. The study will require collecting primary data, which will cause high cost. Apart from these two, the study may face difficulties collecting reliable data from proper sources.

As this study will aim to identify the usefulness of the financial statements in the performance measurement of the companies, it is expected that the study will identify how the financial statements of the companies can help the management and stakeholders in measuring the performance standard. The detailed analysis of the financial statements will show the importance of the statements. At the same time, it is also expected that the results from the analysis of survey and interview data will disclose whether the investors and managers of Woolworths Limited and Wesfarmers Limited find the financial statements useful or not for measuring the performance and taking investment decisions.

Conclusion

This proposal has indicated the research study will aim to identify the usefulness of the financial statements in measuring the performance standards of the companies and taking investment decisions. The literature review of the study has clearly mentioned that the financial statements of Woolworths Limited and Wesfarmers Limited are quite helpful in measuring the performance standards of the companies. Moreover, the discussion in the literature review has also shown how the financial statements can help in comparing the performance standards of the companies in the same industry.

The proposal has stated that the study will follow the positivism philosophy, deductive research approach and descriptive research design because these will help completing the research easily and within less time. As per the research proposal, the study will be based on primary and secondary data and the data will be analyzed with the help of quantitative and qualitative methods of data analysis. The proposal has also indicated that the study will follow a systematic procedure and identify the actual usability of the companies’ financial statements.

References and bibliography

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