LOCAL LITERATURE

Definition of Financial Analysis

A financial statement is a formal record of the financial activities of a business, person or other

entity. Relevant Financial Statement is presented in a structured manner and in a form easy to

understand. Financial Analysis is the process of reviewing and analyzing a company’s financial

statements to make better economic decisions. (Philippine Trade Training Center, 2017)

http://pttc.gov.ph/pttc_trainings/financial-statement-analysis/

Advantages of Financial Statement Analysis

Aside from compliance, audited financial statements could bring more benefits and advantages.

Analyzing financial statements could provide you a number of advantages such as, appraisal of the

company’s operations with the new policies and strategies implemented, determining the strength

and weaknesses of the company’s financial figures that you may optimize opportunities and

remedy weaknesses to prevent wasting financial resources, lastly, it determines the industry’s

position to its competitors. (Tax Accounting Center, 2017)

https://taxacctgcenter.ph/overview-of-financial-statement-analysis-in-philippines/
FOREIGN LITERATURE

Objectives of Financial Analysis

The objectives will vary depending on the perspective of the financial statement user and the

specific questions that are addressed by the analysis of the financial statement data. Among the

several perspectives are that of the creditor, the investor, and the management.

Each of these stakeholders would have to have questions that need to be answered. For instance, a

creditor is usually concerned with the ability of an existing or prospective borrower to make

interest and principal payments on borrowed funds. The investor usually attempts to arrive at an

estimation of a company’s future earnings stream in order to attach a value to the securities being

considered for purchase or liquidation. Lastly, financial statement analysis from the standpoint of

management relates to all of the questions raised by creditors and investors because these user

groups must be satisfied in order for the firm to obtain capital as needed. (Fraser and Ormiston,

2009)

http://ijbssnet.com/journals/Vol_3_No_21_November_2012/19.pdf

Profitability Ratio in a Financial Analysis

Financial statement analysis seeks to evaluate managerial performance in several important areas

including profitability, efficiency and risk. The ultimate goal of that analysis is to provide
insights that will help us project future managerial performance. They also suggest that

financial ratios should be examined relating to the economy, the firm’s industry, firm’s main

competitors and the firm’s past relative ratios. The issue of trade-off between liquidity and

profitability has been discussed intensively since this it is crucially important for companies.

(Reilly and Brown, 2005).

Qualitative Characteristics of Financial Information

The qualitative characteristics will provide assistance when choices have to be made between

reporting policies - whether by preparers, auditors, those participating in the standard-setting

process, regulators or others - and be indicative of the qualities that users can expect of the financial

information provided to them. For financial Information to be useful, should possess some

qualitative characteristics as discussed below: (Libby et al, 2007)

Relevance

For information that is disclosed in the financial reports to be useful at all, it should be

legally relevant. That is, it must be associated with the decisions it is designed to aid and facilitate.

What is relevant for one group of financial information users may not be relevant for another group

of users, thus, there is no such thing as all-purpose financial report in the context. 10 The

information should be relevant to the decision made by the users of the information. It should make

a difference in their decisions. Typically, this means the information must be:

Timely – This means that, the financial information should presented on time. It will enable

also users to make decision concerning the information on time too.

 Have predictive value – Also for financial information to be relevant, must be able to

predict values in future.

Provide useful feedback on past decisions – The financial information should be providing

feedback of what has been decided in the past.

Reliable

The information should be reliable and dependable. This means that users should have a trust on

the financial information supplied with. By having the trust on the information, the users will be

comfortable on relying on it when making decisions. And this reliance will be only achieved if the

following concepts are observed:

Faithful representation – The information represents what it claims to represent. For

example, if the reported value of a common stock holding purports to be the current market

value, that value should be approximately what the stock could be sold for by the company

holding it.

Verifiability – Another person or entity should be able to recreate the reported value using

the same information that the reporting entity had.

Completeness – The reported information should not be missing a material fact or

consideration that would make the reported information misleading. The information

should provide users a sounded picture of the economic activities of the reporting entity.

By this, it means that every aspect of the business which can be reported in monetary terms

11 should be reported as far as possible to give information concerning the result

completely.
 The concept of neutrality – is sometimes incorporated into the concept of reliability. This

means the financial information should be fair to all parts of interests.

Comparable and Consistent

Accounting practices should be uniform both within the corporations and other organizations. Ideal

financial reports of one enterprise should be readily comparable with those of another in the same

industry. Nevertheless, adoption of different accounting policies like the method of depreciation

and stock pricing has made this difficult. For accounting information to be useful, it must allow

for comparisons across time and across competing interests. For instance an Organization should

provide financial data for at least two years. Also an entity should present their financial

information in the way that can be compared with the competing companies in the same industry.

This leads to a need for some consistency, wherever such comparisons are to be expected. For

example, comparisons of two companies would be very difficult and potentially misleading if one

discounts all its liabilities while the other discounts none of its liabilities. For trend analysis the

company must make sure that it obeys consistency in using their Accounting policies like methods

of depreciation and stock valuation methods. If these accounting policies will be used consistently,

now it will be useful for users to make a comparison of profitability, performance and financial

position of the same company between years.

Understandable

Preparation of financial report should be in accordance with general accepted accounting

principles (GAAPs) so that the parties interested to these information can easily understand them.

The financial information are intended to be understood by their users who have reasonable

knowledge of business, economic activities and accounting and who are willing to study the
information diligently. Typically there is a belief that, for information to be understandable,

information contained in the various financial disclosures and reports must be transparent: clearly

disclosed and readily discernable.

Accuracy

The financial reports should disclose correct and accurate information about the financial health

of the business. They should only factual information; no false information is to be included. False

information could lead to wrong decision making. Once the financial information are incorrect, it

will be misleading the users and end up making wrong decision too.

Source: Libby, R et al. (2007). Financial Accounting.5 th Edition: New York, McGraw –

Hill Companies, Inc.

The Importance of Financial Information in relation to Investment Decisions

Reports and interviews with company officials were the most important sources of financial

information in assessing the firm’s value and therefore informing investment decision or equity

selection process.” Investment decision makers use financial statement of different firm’s for

financial decision making purposes. In this instance, financial analyst becomes useful in gathering,

analyzing, and interpreting the accounting results to potential investors for use in making

investment decisions. Publication of financial statement provides a way for banks or firms to

present its financial health or otherwise to shareholders, creditors, general public and to potential

investors, to enable them make rational investment decisions. (Gentry & Fernandez, 2008)
http://www.iosrjournals.org/iosr-jef/papers/Vol8-Issue3/Version-3/D0803032031.pdf

Financial Statement Analysis: A Tool for revealing Red flags & Strengths in an Investment

Decision

Financial statement analysis can reveal the red flags of an investment opportunity. On the other

hand, they can also reveal the strength of the company as well as the potential profit of investing

in a particular company. By their nature, financial statements are retrospective, which means an

investor should never look at a single statistic or matrix in making investment decisions. For

instance, an actual or potential investor must analyze the statement of financial position, to assess

the company’s assets, liability and ownership equities (net worth) at a particular point in time.

Also, the investor will assess the income statement to know company’s expense income and profit

or loss over a specific period of time. He will also assess the cash flow statement, to find out how

the company raised up cash through investors or creditors; how cash is used to acquire assets and

inventory; how the assets and inventory allows the organization to generate cash to pay for

business expenses; and finally how the cash is returned to investors and creditors. Moreover, the

purpose of cash flow analysis is to estimate the amount an investor would receive from an

investment, based on future free cash-flow projections for the company, at least in the short term,

financial information is like an x-ray, they provide multiple angles for proper diagnosis of the

company. Each financial statement provides the user a unique perspective, and together the

statements point a clearer and complete picture into the financial condition of a company. Gentry

& Fernandez, 2008)

http://www.iosrjournals.org/iosr-jef/papers/Vol8-Issue3/Version-3/D0803032031.pdf
Users of Financial Information

Accounting is often called the language of business, all organizations set up an accounting

information system to communicate data to help people make better decisions. The accounting

information system serves many kind of users who can be divided into two groups; internal and

external users as discussed below. (Wild, 2011)

Source: Wild, J. J. (2011). Financial Accounting: Information for decisions. 5th Edition. New

York: McGraw – Hill Companies, Inc.

The Internal users

These are users of the financial information from within an Organization. This includes

management and employees.

Management Team

This is the management of the entity itself. They are concerned with the overall financial worth of

the enterprise. Management has the overall responsibility to see that the resources of the firm are

used most effectively and efficiently and that the firm’s financial position is always sound. They

need the financial statement for planning, controlling and decision making on the day to day

operations and long range (strategic) plan of the organization.

Employees

Employees are interested in the company’s profitability and stability. They are after the ability of

the company to pay salaries and provide employee benefits. They may also be interested in the
company’s financial position and performance to assess the possibility of company expansion and

career opportunities.

The External Users

These are persons or agencies outside the organization who are interested with the company’s

operations. These persons and agencies include;

Prospective Investor

Investors who wish to become shareholders of the firm are more concerned about the firm’s long-

run survival and earnings. They give more confidence in those firms that show steady growth in

earnings. As such they concentrate on the analysis of the firm’s present and future profitability.

Trade Creditor

Trade creditors like suppliers and other short term lenders are more interested in the firm’s ability

to meet their short term obligations. They will confirm their analysis on the evaluation of the firm’s

liquidity position based on the analysis of the firm and determine the terms and conditions of any

lending (or supply) to the firm e.g. security, repayment time etc.

Suppliers

Suppliers of long-term debt would be more concerned with the firm’s long-term solvency and

survival. They analyze the firm’s profitability over time, its ability to generate cash to be able to

pay interest and repay principal and the relationship between various sources of funds (capital

structure relationship). Long-term creditors do analyze the historical financial statement but they
place more emphasis on the firm’s projected or pro-forma financial statements to make analysis

about its future solvency and profitability.

Banks and Other Financial Institution

They study a company’s financial statements to enable them grant loans. They evaluate the ability

of the entity to meet its obligations and the entity’s capital structure relationship.

Government

Governing bodies of the state, especially the tax authorities, are interested in an entity's financial

information for taxation and regulatory purposes. Taxes are computed based on the results of

operations and other tax bases. In general, the state would like to know how much the taxpayer is

making to determine the tax due thereon.

Educational/Research Institution

They require the accounting information for teaching and research purpose. These include

universities and other education centers.

Public

Public are interested in many ways especially the economic life and the sustainability of the

company in its operations.

Stock Exchange

Stock exchange may derive several conclusions from the figures of financial statement such as

performance, profitability prospects of change in the share value and health of the company.
Customers

When there is a long-term involvement or contract between the company and its customers, the

customers may be interested in the company’s ability to continue existence and its stability of

operations. This need is also sensitive in cases where the customers depend upon the entity.

For example, a distributor (reseller), the customer in this case, is dependent upon the

manufacturing company from which it purchases the items it resells.

Potential Buyers (Acquirers)

Potential buyers of the firm through acquisition or merger are more concerned about the potential

profitability of the firm in the future as such they decide on the reasonable price to pay and the

actions to be taken on the purchase of the firm or merger.

Definition and Nature of Investment Decisions

Investment decisions or analysis has to do with an efficient allocation of capital. It involves

decision to commit the firm’s funds to the long-term assets. Such decisions are of considerable

importance to the firm since they tend to determine its value size by influencing its growths,

profitability and risk The investment decisions of a firm are generally known as the capital

budgeting decision may be defined as the firm’s decision to invest its current funds most efficiently

in the long-term assets in anticipated of an expected flow of benefits over a series of years.

(Pandey, 2010)

Investment Decision are the series of decisions by individual economic units as to how much and

where resources will be obtained and expected for future. Situation where capital expenditure
decisions are made or taken, they are based primary with measurement of capital productivity

which provides an objective means of measuring the economic worth of individual investment

proposals in order to have a realistic basis for choosing among the firm’s long run property.

(Canada and White, 2010)

Source: Pandey, I. M. (2010). Financial Management. 10th Edition. New Delhi: Vikas Publishing

House

Importance of Investment Decision

Investment decisions require special attention because of the following reasons;

 They influence the firm’s growth in the long-run.

 They affect the risk of the firm.

 They involve a commitment of large amount of funds.

 They are irreversible or reversible at substantial loss.

 They are among the most difficult decisions to make.

Growth: the effects of investment decisions extend into the future and have to be endured for a

longer period than the consequences of the current operating expenditures.

A firm’s decision to invest in long- term assets has a crucial influence on the rate and directions

of its growth. A wrong decision can prove disastrous for the firm. On the other hand, inadequate

investment in assets would make it difficult for the firm to complete successfully and maintain its

market share.

Risk: A long-term commitment of funds may also change the risk complexity of the firm. Risk

arises in investment clue to the inability to anticipate the occurrence of the possible future events
with certainty and consequently, cannot make any adoption of an investment increase average gain

but causes frequent fluctuations in its earnings, the firm will become more risky. Thus, investment

decisions shape the basic character of a firm.

Funding: Investment decision generally involve large amount of funds which make it imperative

for the firm to plan investment programs very carefully and make an advance arrangement for

procuring financial internally or externally.

Irreversibility: Most investment decision is irreversible. It is difficult to find a market for such

capital items once they have been acquired. The firm will incur heavy losses if such assets are

scrapped.

Complexity: Investment decisions are among the firms which are mostly difficult to make

decisions. There are assessments of future events which are difficult to predict. It is really a

complex problem to correctly estimate the future cash flow of an investment.

The uncertainty in cash flow is caused by economic, political, social and technological forces.

http://www.economicsdiscussion.net/investment-decisions/investment-decisions-meaning-need-

and-factors-affecting-it/21976

Role of Financial Information in Investment Decision Making

The aim of financial information is to provide information about an entity to interested parties.

The information contained in the reports, however, it can only become meaningful through

financial interpretations derived from the analysis of the reported data. This interpretations and
decision unveils the essence of financial reports, as the major custodian of financial information

necessary for any investment decisions.

Investment decisions are not made on a vacuum hence; there are bases on which they will stand.

One major tool for these investment decisions is the ratio analysis. Financial analysis is the

judgmental process which aims at evaluating the current and past financial positions and the results

of an entity. The primary objectives of determining the best possible estimate about the future

conditions and performances. It provides a quick diagnostic look at an entity’s financial health and

trigger off subsequent financial and operational analysis, the figures that are used in the financial

analysis are being dedicated from the financial information which in turn inform our decision

maker. Several ratios exists but this research work will look on other major rules that are used in

investment decision that financial information are the major source of the raw materials for the

investment decisions.

• In the expansion of the existing business, the financial information can enable the decision

maker, by informing on the profitability of the business and its going concern status.

• In acquisition of a new investment project, the financial information give the raw

information to the investor, for analyzing the future expected profitability of the business.

• On replacement of the investment project, also the financial information enables the

decision maker to assess the contribution margin of the project. This is done to improve

efficiency and reduce cost.

(Check this link, study siya and medyo may connect sa research natin)
http://scholar.mzumbe.ac.tz/bitstream/handle/11192/1193/MSc_A%20%26%20F_Mrisho%20Sa

muel_2014.pdf?sequence=1