Use of Accounting Ratio in Business Decisions

ABSTRACT

Accounting ratios are crucial tools used by management, investors, creditors, and other stakeholders in making informed business decisions. Their application remains indispensable in assessing the financial health and performance of organizations. This study is divided into five chapters. The first chapter introduces the topic by defining accounting ratios, stating the research problem, objectives, and limitations. Chapter two presents a review of related literature and a brief profile of Nigerian Breweries PLC. Chapter three discusses the research methodology, while chapter four focuses on data analysis and interpretation. Finally, chapter five provides the summary, recommendations, and conclusion. Any errors found are unintentional and deeply regretted.

CHAPTER ONE

INTRODUCTION

1.1 Background of the Study

Omuya (1990) described accounting as the “language of business” used to communicate the financial transactions of all kinds of organizations. This definition highlights that accounting transforms raw financial data into useful information for decision-making. It enables effective financial communication by presenting information in a structured and comprehensible manner for users.

Similarly, Millichamp (1992) defined accounting as “the art of recording, classifying, and summarizing in a significant manner and in terms of money transactions and events which are at least partly financial.” The users of accounting information include shareholders, managers, suppliers, customers, government agencies, and employees. However, for financial statements to be meaningful, users must understand, interpret, and analyze them effectively.

Users often seek three key insights from financial statements:

1. The ability of a business to remain solvent and sustainable in the long term.

2. The quality of management and the soundness of their decisions.

3. Information that can guide future business actions.

Unfortunately, many users struggle to interpret financial statements correctly, which often leads to poor investment and business decisions. As a result, individuals and firms may suffer significant financial losses or develop mistrust toward investment opportunities. These poor decisions not only affect management and investors but also hinder overall economic growth and development.

This persistent problem inspired the present study. The research focuses on how accounting ratios—an essential analytical tool—can improve the quality of business decisions. According to Atman (1968), ratios express the mathematical relationship between two figures from the same or different financial statements. Likewise, Millichamp (1992) noted that ratio analysis is used to assess a firm’s performance and liquidity and to forecast future trends. Therefore, ratio analysis remains a valuable method for making sound business decisions.

1.2 Statement of the Problem

Despite the growing importance of accounting ratios, many users of financial statements are still unable to apply them effectively in decision-making. Although numerous seminars and workshops have been organized to educate financial statement users, the number of poor business decisions continues to rise. This situation may stem from the users’ disregard for ratio analysis or their confusion about how to interpret ratios correctly. Consequently, this lack of analytical skill has led to avoidable financial losses and inefficiencies in business operations. Addressing this gap forms the central concern of this research.

1.3 Objectives of the Study

The main objective of this study is to examine how accounting ratios influence business decision-making. Specifically, the study seeks to:

1. Determine whether accounting ratios confuse financial statement users and increase the likelihood of poor decisions.

2. Assess whether ignorance of the importance of accounting ratios contributes to defective decision-making.

3. Examine whether negligence and disregard for ratio analysis lead to wrong business decisions.

1.4 Research Questions

The study aims to answer the following questions:

a. Do accounting ratios confuse financial statement users and lead to poor business decisions?
b. Is the ignorance of accounting ratios responsible for faulty business decisions?
c. Does neglecting ratio analysis result in poor decision-making?
d. Do financial statements contain discrepancies that mislead users?
e. Do users require more training and enlightenment to understand financial statements better?
f. To what extent can accounting ratios be used as a reliable tool for business decision-making?

1.5 Significance of the Study

This study is significant for several reasons. Firstly, it bridges the gap in existing literature by focusing on the link between ratio analysis and business decision-making. While previous scholars have emphasized financial analysis in general, few have examined its direct role in preventing poor business choices.

Secondly, the study provides practical value to business managers and investors. With the help of accounting ratios, managers can evaluate their firm’s performance, identify inefficiencies, and control operations more effectively. Creditors can assess a firm’s ability to repay debts, while investors can predict its financial future before committing funds.

Furthermore, the findings serve as a reference point for future researchers interested in financial analysis, investment decisions, or corporate performance evaluation.

1.6 Formulation of Hypotheses

The study tests the following hypotheses:

Hypothesis 1
H₀: Accounting ratios are not useful in making business decisions.
H₁: Accounting ratios are useful in making business decisions.

Hypothesis 2
H₀: Accounting ratios do not accelerate business decision-making.
H₁: Accounting ratios accelerate business decision-making.

Hypothesis 3
H₀: Management does not evaluate efficiency and effectiveness using accounting ratios.
H₁: Management evaluates efficiency and effectiveness using accounting ratios.

Hypothesis 4
H₀: Neglecting accounting ratios does not result in risky business decisions.
H₁: Neglecting accounting ratios results in risky business decisions.

Hypothesis 5
H₀: Accounting ratios do not reveal unproductive departments.
H₁: Accounting ratios reveal unproductive departments.

Hypothesis 6
H₀: The company does not compute accounting ratios.
H₁: The company computes accounting ratios.

Hypothesis 7
H₀: Accounting ratios do not help identify the strengths and weaknesses of a company.
H₁: Accounting ratios help identify the strengths and weaknesses of a company.

1.7 Definition of Terms

• Ratio: A numerical expression showing the relationship between two figures.

• Shareholders: Individuals or entities that own shares in a company.

• Financial Statements: Formal records that summarize the financial activities and position of a business, including the balance sheet, income statement, and cash flow statement.

• Accounting Period: A standard 12-month financial reporting cycle, often from January 1 to December 31.

• Analysis: The process of separating complex data into parts to interpret financial performance and position.