THE ROLE OF FINANCIAL STATEMENTS IN INVESTMENT DECISIONS

posted on January 30, 2020

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND OF THE STUDY

Every business prepares profit and loss Account or income statement to ascertain the net result of financial working of the business whether it has earned some income or profit or sustained any loss. It also prepare balance sheet to find out the financial position of the business. Profit and loss account or income statement, retained earnings statement and balance sheet are known as financial statements. Gautam (2005) sees financial statement as financial information which is the information relating to the financial position of any firm; when presented in a concise and capsule form. Besides profit and loss account and balance sheet, some other statements are also prepared for deriving certain conclusions. A schedule of current assets and current liabilities of two years may be prepared to know the changes in working capital. Similarly a fund flow statement and cash flow statement may also be prepared to ascertain the future estimate of cash receipt and payment. Thus, financial statement include: profit and loss Account, income statement and balance sheet along with certain schedules and statement.

Ezeamama (2010) is of the opinion that rational decisions have to be taken to manage modern business successfully and for this rational decision to be taken in line with the firms’ objective. Some analytical tools ought to be available and used based on the strengths and weakness of the firms. Thus, the financial strengths and weaknesses of a firm are revealed in its financial statement. The nature of financial statement is that financial statement is that financial statements always relate to a past period and hence they are called historical documents. Financial statements are expressed in monetary terms and it indicates profit abilities of the business through balance sheet. Financial statement are analyzed in order to use the information in financial statements to ascertain the profitability and financial soundness of the firm, to Judge the managerial efficiency for inter form comparison of similar nature and to make valuable for costs. According to Remi Aborode (2006), financial statement need to be interpreted for better understanding and analysis and it can thus be interpreted using individual items contained in financial statement or/ and using ratios computed from items contained in financial statement ( Ratio analysis). The essentials of financial statements range from the fact that financial statements should disclose correct information about profitability and financial position of a business. The information disclosed should be presented in such a manner that it can be easily compared with the figures of the previous year or with those of other similar firms. The information so provided in financial statement should be that which can be verified from the relevant and prepared within a reasonable time after the end of accounting period. The information provided by financial statement should also be easily understood by the interested parties.