The Use Of Accounting Ratio Analysis In Decision Making Process

Methodology

This structured abstract, review the study of the responsibility of accounting ratio analysis in taking business decision, through research studies conducted by Damjibhai, Brown, Ak, and Daniel,

Damjibhai, (2016), stated that ratio analysis was developed long ago. Ratio analysis was mainly used in analyzing ratio properties. Damjibhai, (2016) further states that ratio analysis was mainly used in the modern times as tools of analyzing financial statements. In the 19^th century, ratio analysis was also used to represent the financial power of an institution and make adjustments in the management. The major purposes of financial analysis are managerial and credit. Damjibhai, (2016) confirms that the main focus in managerial approach is profitability while in Credit is ability to pay the debts. In most cases, ratio analysis is used in credit analysis.

 Brown, (2008), says that business relationship is portrayed through ratios. Brown, (2008), also developed a complete model based on the ratios. Although, this model is not mature it gave others an opportunity to work on this theory. Since ratio analysis was a big issue several people criticized its concepts.

Damjibhai, (2016), had several concerns about this issue. First, he says that ratios are bound with time and are always changing thus difficult to interpret. Second, ratios cannot be used to judge a company’s performance. Third, ratios have an effect on a viewer’s mind and can easily hide the real position of an organization. Fourth, ratios change regularly and will affect dependability. To solve the criticism (Ak, 2013) created and promoted successful financial ratios. These ratios were printed and have then been known worldwide to be the best.

AK, (2013), further analyzed a hundred and twenty failed firms by using 13 different ratios. Out of the thirteen, three forecasted the failure of the firms accurately while others showed some predictive power.

Also, Daniel, (2015) made use of eleven ratios to determine if successful firms had higher ratios than unsuccessful ones. Though this study was not mature, that aspect was ignored by looking at the contributions the study had on the assessment of how useful the ratios were. Later on, exchange in commission and security was developed. This helped expand the flow of the financial statements as well and the number. This also helped enhance and realize the vitality of the ratio analysis.

In the 19^th century, financial information and knowledge rapidly expanded. Damjibhai, (2016), also made comparisons of related items and then linked assets and liabilities. Other ratios were also compared. Current ratio was the most important ratio at that time when compared to other ratios. DuPont analysis was used in analyzing the operational results. The results were then partitioned into three portions then this was compared to other companies in order to highlight the problems and the stronger business areas. In many different enterprises, process of making decisions is the most fundamental in managing all enterprise operations. These enterprises may be profit-oriented or non-profit oriented. The research made was for profit-oriented firms where decision making process is based on the different concepts. Among the concepts in these enterprises is the accounting ratios that should have a huge effect.

Review of Literature

In the decision-making process, financial reporting is the main concept. According to Daniel, (2015), financial reporting is not the main information in a business but it provides the necessary information in business making processes and economic decisions. This is why the (Brown, 2008), was so much keen in determining the extent to which management dealers depend on the accounting ratios. It is therefore good to say that financial statements have a huge effect on investment decisions. They help provide investors with information about project analysis, performance of a company financial and the position of a company financially.

Damjibhai, (2016), says that, decision making process is such a vital issue in any institution. Presence of valuable information is one of the hypothetical evidence of good decisions. Accounting systems and financial statements provide this information. Financial statements provide the realistic information about a company. Proper auditing of the financial statements must be regularly done to ensure accuracy. Different financial statements users should be able to read and comprehend the information from the financial statements. Ability to read the financial reports will provide different ways and procedures in comprehending business operations. Brown, (2008) states that good and well-organized financial statements and information is assumed to provide an efficient business. 

Ak, (2013) says, financial reports help obtain information about company’s financial position in the past and the present. They also help make those events not perceived much to be visible. Additionally, they provide general summary of the company and help management anticipate for the future events. Information about finances must be relevant, intangible, comparable and reliable so that it can be deemed as useful. Decision making process does not only rely on the information obtained but also on the representations and personal beliefs of people.

According to Daniel, (2015), ratio analysis was developed to do quantitative/ comparison analysis on the figures of financial statements. Ratios help create a link between three different statements and provide figures that can be compared between companies and industrial sectors. It is therefore one of the most widely used tool in making analysis in firms. Brown, (2008) used secondary data in conducting the qualitative evaluation of accounting ratio analysis. There was no use of primary data. He also confirmed that his research was unsuccessful due to lack companies that apply extreme accounting ratios. Additionally, this research depended on a place in this case Wilmington in the USA was where the study was conducted. Several challenges were encountered during the research. There were methodological problems too that were faced (Damjibhai, (2016). The use of sampling led to self-selection bias. It is important to note that the quantitative methodology had a lot of limitations unlike qualitative methodology on sample selection approaches. Hence being effective on a few samples.

These ratios vary from different industries and comparisons between some companies might at all be not true. Trends in the financial ratio analysis must be adequately analysed instead of looking at single figures in financial reports.

Daniel, (2015), stated that financial reports and statements contain so much information that is sometimes in figures. These reports may not provide all the information regarding how viable the figures are. Hence, analysis must be done in order to obtain some comparisons and better decisions. Financial ratios are suitable in doing that. In these articles, ratio analysis helped in revealing, comparing and interpreting the striking characteristics of this financial reports or statements. According to Daniel, (2015), accounting ratio analysis, help show the financial position and performance of an organization. They also help show results of company operations and identify weaknesses and strengths in a company. They help show the past, present and future performance of an organization. They enable us understand our business and make proper assessments in obtaining rigid and more concrete answers. Ratio analysis will actually help in planning, forecasting and decision-making processes.

Ratio analysis are essential in making anticipations of the company’s performance. Therefore, when conducting ratio analysis, it is significant to reduce errors, this helps increase efficiency in the companies. Inefficient ratio analysis combined with the reduces errors will help enhance accuracy in the business operations. Damjibhai, (2016), suggests that financial statements users must have adequate knowledge of accounting. Investors should also adequately analyze the financial statements before making decisions. 

Ak, B. K., 2013. The use of financial ratio models to help investors predict and interpret significant corporate events. Australian Journal of Management, 38(3), pp. 10-29.

Brown, R., 2008. Financial statement analysis and accounting policy choice: What history can teach us. Journal of Applied Accounting Research, 8(3), pp. 2-10.

Damjibhai, S. D., 2016. Performance Measurement through Ratio Analysis: The Case of Indian Hotel Company Ltd. Journal of Management Research, 15(1), pp. 5-19.

Daniel, G. A., 2015. A Consensus on Commonly used Financial, Romania: West University of Timi?oara.