The use of accounting ratios in decision making

DEDICATION

To the Almighty God
To my late parents
To my late brother KALISA P.
To my brother KWIZERA J D
To the family HABIRYAYO Cyprien
To my friends and relatives
I dedicate this dissertation «God bless you»

II
DECLARATION

I, KABERA Lambert, hereby declare that this dissertation entitled «The use of accounting ratios in decision making» is my own work and it has not been submitted anywhere for the award of any degree

Student's Names

Student's signature

III
ACKNOWLDGEMENT

I am thankful to many individuals who have contributed to the accomplishment of this dissertation. Special appreciation goes to my director Prof RAMA B. RAO for his pieces of advice and corrections throughout the course of the course of this research.

Further thanks go to the Faculty of Economics and Management especially to the Head of the Management Department and all lecturers for their tireless efforts towards the accomplishment of this dissertation in particular and the completion of my course in general.

I further convey my gratitude to the family Habiryayo Cyprien, the family Munyengabe Joseph, the family Munyanziza Andre, my cousins, brother and sisters for their financial and moral support rendered to me over since I lost my both parents.

My thanks go especially to Mrs Kabarere Venantie for her role played in the darkness event that I passed through, also for both my grandmothers, uncles and aunts I do recognize their effort to help me to recover when I lost my parents.

Further appreciation goes to my friends Ndati, Kibonge Sam, Hilde, Tiro, Makombe, Muhire and I would like to extent my heart-felt appreciation to all BAS Year IV 2005-2009 friends for their co-operation during my stay at NUR.

Last but not least, my best regards go to the Government of Rwanda that granted me a Scholar ship at the National University of Rwanda as well as for AMAZI YA HUYE management staff for being cooperative with me to conduct my research on their company.

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TABLE OF CONTENTS

DEDICATION I

DECLARATION II

ACKNOWLDGEMENT III

TABLE OF CONTENTS IV

LIST OF ACCRONYMES AND ABBREVIATIONS VII

LIST OF TABLES VIII

LIST OF FIGURES IX

ABSTRACT XI

CHAPTER 1 1

INTRODUCTION 1

1 1 BACKGROUND OF THE STUDY 1

1 2 STATEMENT OF THE PROBLEM 2

1 3 RESEARCH QUESTIONS 3

1 4 OBJECTIVES OF THE STUDY 3

1 5 HYPOTHESES 3

1 6 SIGNIFICANCE OF THE STUDY 4

1 7 SCOPE OF THE STUDY 4

1 8 ORGANIZATION OF THE STUDY 4

CHAPTER II 6

LITERATURE REVIEW 6

2.0 INTRODUCTION 6

2 1 DEFINITION OF KEY TERMS 6

2 1 1 Accounting 6

2 1 2 Ratios 6

2.1.3 Accounting ratios 6

2 1 4 Financial ratios 7

2 1 5 Decision making 7

2 2 ESSENCE OF RATIOS ANALYSIS 7

2 3 STANDARDS OF COMPARISON 7

2 3 1 Time series analysis 8

2 3 2 Pro forma analysis 8

2 3 3 Industry analysis 8

2 3 4 Cross-sectional analysis 9

2 4 TYPES OF ANALYSIS USING ACCOUNTING RATIOS IN DECISIONS MAKING 9

2 4 1 Analyzing Liquidity 9

V

2.4.2 Analyzing Debt 9

2 4 3 Analyzing Sales and Profita bility 10

2 4 4 Analyzing Efficiency 12

2.4.5 Multiple Discriminant Analysis 12

2.4.6 Trend Analysis 13

2.5 THE COMPONENTS OF DECISION MAKING 13

2.5.1 Decision environment 13

2.5.2 Decision Model 14

2.6 USES AND LIMITATIONS OF RATIO ANALYSIS 15

2.6.1 Uses 15

2.6.2 Limitations 15

CHAPITER III 16

METHODOLOGY 16

3 0 INTRODUCTION 16

3 1 RESEARCH DESIGN 16

3 1 1 The analyti cal research 16

3 2 POPULATION OF THE STUDY 17

3 3 SOURCES OF DATA 17

3 3 1 Primary Data 17

3 3 2 Secondary Data 18

3 4 DATA COLLECTION TECHNIQUES 18

3 4 1 Documentary Review 18

3 4 2 Document Analysis 18

3 4 3 Interview Guide 19

3 4 4 Sample size and selection 19

3 5 SAMPLING TECHNIQUE 19

3 6 DATA PROCESSING AND ANALYSIS 19

3 7 STUDY LIMITATIONS 20

CHAPTER IV 21

DATA ANALYSIS AND INTERPRETATION 21

4 1 INTRODUCTION 21

4 2 THE PROFILE OF AMAZI YA HUYE 21

4 1 2 AMAZI YA HUYE location 21

4 3 AMAZI YA HUYE'S MISSION 22

4 4 AMAZI YA HUYE'S OBJECTIVES 22

4 5 THE ENVIRONMENT OF AMAZI YA HUYE 22

4 6 JURIDICAL STATUTE OF AMAZI YA HUYE 23

4 7 TASKS DESCRIPTION 23

4 8 DATA ANALYSIS 25

4 8 1 In depth Interview 26

4 8 3 Preferred ratios in decision making 27

4 10 ACCOUNTING RATIOS AND DECISION MAKING 29

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4 11 ANALYSIS OF ACCOUNTING RATIO AS A DECISION MODEL 30

4 11 1 Liquidity analysis 30

4 11 2 Debt analysis 33

4 11 3 Sales and profitability analysis 34

4 11 4 Efficiency analysis 38

4 11 5 Multiple discriminant analysis 40

4 12 HYPOTHESIS TESTING 41

CHAPTER V 43

SUMMARY, CONLUSION AND RECOMMENDATIONS 43

5 1 SUMMARY 43

5 2 CONCLUSION 44

5 3 RECOMMENDATIONS 46

5 6 AREA FOR FURTHER RESEARCH 47

BIBLIOGRAPHY 48

APPENDICES 50

VII
LIST OF ACCRONYMES AND ABBREVIATIONS

A P: Accounts payable

BAS: Bachelor of Accounting Sciences

EAT: Earnings after taxes

EBIT: Earnings before interest and taxes

ICPAR: Institute of Certified Public Accountants of Rwanda

MDA: Multiple Discriminant Analysis

NUR: National University of Rwanda

ROA: Return on assets ROE: Return on equity ROI: Return on investment ROS: Return on sales

SGR: Sustainable growth rate

VIII
LIST OF TABLES

TABLE 3 1 TOTAL POPULATION OF MANAGEMENT AND ACCOUNTING DEPARTMENTS OF AMAZI YA HUYE 17

TABLE 4 1 RESPONDENTS' VIEW ON THE LINKAGE BETWEEN ACCOUNTING RATIOS AND DECISION MAKING 29

TABLE 4 2 TREND OF LIQUIDITY RATIOS 31

TABLE 4 3 TREND OF DEBT RATIOS 33

TABLE 4 4 TREND OF SALES AND PROFITABILITY RATIOS 35

TABLE 4 5 TREND OF EFFICIENCY RATIOS 38

TABLE 4 6 TREND OF MULTIPLE DISCRIMINANT ANALYSIS 40

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LIST OF FIGURES

FIGURE 4 1 ORGANIZATION STRUCTURE OF AMAZI YA HUYE 23

FIGURE 4 2 AMAZI YA HUYE LIQUIDITY RATIOS 2003 - 2007 32

FIGURE 4 3 AMAZI YA HUYE DEBT RATIOS 2003 - 2007 34

FIGURE 4 4 AMAZI YA HUYE EXPENSES ANALYSIS, GROSS MARGIN TO SALES, RETURN ON SALES RATIOS 2003-2007

37

FIGURE 4 5 AMAZI YA HUYE RECEIVABLES AND PAYABLES TURNOVER RATIOS 2003-2007 39

FIGURE 4 6 AMAZI YA HUYE MULTIPLE DISCRIMINANT ANALYSIS 2 003-2007 41

x
LIST OF APPENDICES

1. A qui de droit

2. The letter of request for collaboration in the research

3. Interview guide

4. Financial statements of AMAZI YA HUYE

xi
ABSTRACT

This research entitled» The use of accounting ratios in decision making» tried to find out the degree to which accounting ratios can be used to draw conclusion upon which decision are made. This has been done considering AMAZI YA HUYE as a case study. The research specifically had to identify different ratios used in financial statement analysis in decision making, also the role of financial ratios analysis in decision making had to be indicated and lastly the use and limitation of accounting ratios .

Both secondary and primary data were consulted during this research. Primary data was collected with the help of interview given to the members of the management staff. Respondents were selected based on their role in financial activities in AMAZI YA HUYE. Under secondary data financial statements of AMAZI YA HUYE, textbooks, and internet resources were consulted.

This study revealed that the accounting ratios are indispensable in reasonable decision making. Generally, some of business entity uses accounting ratios in a proper way. The use of accounting ratios in financial statements analysis varies according to the decision to be made by those who use them. Different managers use different analytical tools and techniques depending on the objectives of the analyst and nature of the business, it was further found out that the accounting ratios reduce the long array of financial statement in decision making.

On the basis of the study's major findings, there was no sufficient evaluation to reject the alternative, namely,» The use of accounting ratios guides management as an effective tool in decision-making.

CHAPTER 1

INTRODUCTION

1 1 Background of the study

This research is about the impact of using accounting ratios in decision making. Decision making is the most important element in management activities of all kinds of enterprises; profit oriented, nonprofit oriented and public institutions. This research is carried out in profit oriented enterprise where decisions are made based on different aspects among which the use of accounting ratios should have a great impact.

The use of financial reporting is the main aspect in decision making. According to (Charles H. GIBSON, 1989: 10), financial reporting is not the end in its self but it is intended to provide information that is useful in making business and economic decisions. It is in this regard the researcher was motivated in finding the extent to which management dealers may depend on accounting ratios in decision making.

The main objective of this chapter is to introduce the researcher' s topic and its content include : background of the study, statement of the problem, objectives of the study, hypothesis, research questions, significance of the study, scope of the study and organisation of the study.

As an art, management has been practised since the early beginning of twentieth century. It had got a great evolution at the time of industrial revolution which started in England around mideighteenth century. Prior to this, most of business enterprises were characterised by craftsmanship rather than mechanisation or technology and faced the problem much simpler than those faced today's firms in our complex industrial and technological society.

With reference to this industrial revolution till nowadays; legal, social and technological environment tend to generate industrial growth and economical environment development that prompt entrepreneurs to react. At the same time when these changes taking place, there were basic changes in the form of management especially in managerial strategies for decision making; this generates separation of ownership of the business from its management.

In consequences, managers had to look for the means of discharging their stewardship responsibility; this can be obtained through the use of accounting ratios.

The use of accounting ratios is a time-tested method of analyzing a business. Wall Street investment firms, bank loan officers and knowledgeable business owners all use accounting ratio analysis to learn more about a company's current financial health as well as its potential (P. Vernmmen, 2006).

Ratios analysis simplified, summarises, and systematises a long array of accounting figures. Its main contribution lies in bringing out the inter-relationship which exists between various segments of business. Ratios are more of a diagnostic tool that helps to identify problem areas and opportunities within a company.

1 2 Statement of the problem

The management of enterprise is depending on accounting information for taking various strategic decisions. Financial statements provide such information. This information is made useful by analyzing and interpretation of financial statements with help of financial analysis techniques among which the common and easy technique to use is financial ratios also known as accounting ratios. (Prof. Harvey B. Lermack, 2003).

(James C. Van Horne and John M. Wachowicz, 2005: 132) say «to evaluate the firm's financial condition and performance, the financial analysis needs to perform checkups on various aspects of a firm's financial health. A tool frequently used during these checkups is financial ratios».

Accounting ratios are important tools in the management for decision making. (R.K. Sharma, Shashi K. Gupta, 2001: 4.4), financial statements are prepared primarily for decision making, but the information provided in financial statements is not an end in itself and no meaningful conclusion can be drawn from these statements alone. Ratio analysis helps in making decisions from the information provided in these financial statements. Thus, the proper use of accounting ratios assists management in communicating information which is pertinent and purposeful for decision makers to ensure the effectiveness of management in the enterprise.

In modern business environment, which is becoming more competitive, the survival of firms, be it small or large; depend upon the strategic decisions made by management. This is however done with the help of accounting ratios, which is a big challenge to most countries having shortage of professional accountants as it is the case to our country.

As such, this study is aimed at finding out the impact of using accounting ratios in assisting rational decision making by Rwandan business community with more emphasis on the management of AMAZI YA HUYE.

1 3 Research questions

The researcher has been guided by the following research questions while carrying out his study.

1. Why should managers rely on accounting ratios in decision making?

2. Of what significance are different types of accounting ratios to management in decision making?

3. What is the requirement needed to use accounting ratios? 1 4 Objectives of the study

The general objective of this study is to exanimate the impact of using accounting ratios for decision making. The specific objectives are as follows:

1. To understand the importance of using accounting ratios as a pillar to draw conclusions upon which decisions are made;

2. To identify hindrances of using accounting ratios in AMAZI YA HUYE;

3. To provide suggestion for further improvement.

1 5 Hypotheses

1. The use of accounting ratios guides management as an effective tool in decision making;

2. The result of using accounting ratios relies on the effectiveness of accounting and how accountants are skilled in financial analysis techniques.

1 6 Significance of the study

This study is of importance to the researcher as it equips him the knowledge of financial analysis techniques and interpretation of the available data for managerial purpose using accounting ratios. I t further helps in designating proper solution for identified problems.

The research enable managers to understand better the role that plays accounting ratios in decision making and it will attempt to make a causative analysis and designed the possible alternative for improvement of managerial decisions for growth of AMAZI YA HUYE, these would thus become a basis for further research and provide the necessary information for action by the concerned parties. Finally, this study will enable the researcher to obtain a Bachelor' degree in Accounting Sciences.

1 7 Scope of the study

The study will make a great emphasis on analysis of financial reports of AMAZI YA HUYE using accounting ratios. This report is made of all balance sheets, income statements over the last 5 years period, that from 2003 to 2007.

1 8 Organization of the study

The study is divided into five chapters. The first chap ter will be made up of introduction, background of the study, statement of the problem, research questions, and objectives of the study, hypothesis, methodology, and significance of the study, scope of the study and organization of the study.

with the research topic will be defined ,the accent will be put on the impact of using accounting ratios for decision making.

The third chapter will identify methodology to follow while conducting this research.

Chapter four will focus on the research findings analysis and interpenetration of data collected. Findings will be linked with objectives set.

Chapter five will present summary of research findings, conclusion and recommendations.

CHAPTER II

LITERATURE REVIEW

2.0 Introduction

This chapter presents the related literature and concepts about accounting ratios and decision making. Accounting ratios as an integral part in decision making, the researcher wanted to investigate whether the use of accounting ratios can intervene in decision making in AMAZI YA HUYE. Using accounting ratios and decision making concepts, the researcher will attempt to relate their theories and what could be their applicability in AMAZI YA HUYE.

2 1 Definition of key terms

2 1 1 Accounting

Accountancy or accounting is the art of communicating financial information about a business entity to users such as shareholders and managers. The communication is generally in the form of financial statements that show in money terms the economic resources under the control of management.

2 1 2 Ratios

According to the Webster's New Collegiate Dictionary, Mass: G&C (1975: 958), a ratio is defined as «the indicated quotient of two mathematical expressions» and as «the relation between two or more things»

(Rustagi R.P., 2000: 53) notes that; a ratio is a relationship expressed in mathematical terms between two individual and groups of figures connected with each other in some logical manner.

2.1.3 Accounting ratios

2 1 4 Financial ratios

These are tools for interpreting financial statements to provide a basis for valuing securities and appraising financial and management performance.

2 1 5 Decision making

It is the study of identifying and choosing alternatives based on the values and preferences of the decision maker. Decision making is also the process of sufficiently reducing uncertainty and doubt about alternatives to allow a reasonable choice to be made from among them. (Robert Version, 1998).

2 2 Essence of Ratios Analysis

The essence of the financial soundness of a company lies in balancing its goals, commercial strategy, product-market choices and resultant financial needs. The company should have financial capability and flexibility to pursue its commercial strategy.

According to (Butters, K.J., 1981: 3-7), ratio analysis is a very useful analytical technique to raise pertinent questions on a number of managerial issues. While assessing the financial health of a company with the help of ratio analysis answers to questions relating to the company's profitability, as sets utilization, liquidity, financing and strategies capabilities may be sought.

2 3 Standards of Comparison

The ratio analysis involves comparison for useful interpretation of financial statements. A single ratio in itself does not indicate favorable or unfavorable condition. It should be compared with some standard.

According to (Anthony, R. N. and Reece, J. S, 1975: 260-263), standards of comparison may consist of:


· Past ratios: ratios calculated from the past financial statements of the same firm;


· proj ected ratios: ratios developed using the projected or pro forma financial statements of the same firm;

· competitors `ratios: ratios of some selected firms, especially the most progressive and successful competitor, at the same point in time and

· Industry ratios: ratios of the industry to which the firm belongs. 2 3 1 Time series analysis

This is the way used to evaluate the performance of a firm by comparing its current ratios with the past ratios. It gives an indication of the direction of change and reflects whether the firm's financial performance has improved, deteriorated or remained constant over time. (I. M Pandey, 1995: 105)

2 3 2 Pro forma analysis

Sometimes future ratios are used as a standard of comparison. Future ratios can be developed from the pro forma financial statements. The comparison of current ratios and the future ratios shows the firm's relative strengths and weaknesses in the past ant the future ratios indicate weak financial position, corrective actions should be initiated. (I. M Pandey, 1995: 105)

2 3 3 Industry analysis

To determine the financial condition and performance of a firm, its ratios may be compared with average ratios of industry of which a firm is a member. This sort of analysis helps to ascertain financial standing and capability of the firm vis-à-vis other firms in the industry. Industry ratios are important standards in view of the fact each industry has its characteristics which influence the financial and operating relationship. (I. M Pandey, 1995: 105)

2 3 4 Cross-sectional analysis

It consists at comparing ratios of one firm with some selected firms in the same industry at the same point of time. This kind of a comparison indicates the relative financial position and performance of the firm. A firm can hardly resort to such a comparison, as it is difficult to get the published financial statements of the similar firm. (I. M Pandey, 1995: 105)

2 4 Types of analysis using accounting ratios in decisions making

2 4 1 Analyzing Liquidity

Liquid assets are those assets that can be converted into cash quickly. The short-term liquidity ratios show the firm's ability to meet short-term obligations. Thus a higher ratio (#1 and #2) would indicate a greater liquidity and lower risk for short-term lenders. The Rule of Thumb (for acceptable values): Current Ratio (2:1), Quick Ratio (1:1) While high liquidity means that the company will not default on its short-term obligations, note that by retaining assets as cash, valuable investment opportunities might be lost. Obviously, Cash by itself does not generate any return only if it is invested will we get future return. In quick ratio, we subtract the inventories from total current assets since they are the least liquid (among the current assets. (Prof. Phill Russeil, 2003)

Since the cash is the most liquid asset, a financial analyst may examine the ratio of cash and its equivalent to current liabilities. Trade investment and marketable securities are equivalent of cash therefore they may be included in the computation of current ratio. (I.M Pandey, 1995: 112).

1. Current Ratio = Total Current Assets/Total Current Liabilities

2. Quick or Acid-test Ratio = Total Current Assets - Inventories /Total Current Liabilities

3. Cash ratio = Cash + Marketable securities/Current liabilities.

These ratios show the extent to which a firm is relying on debt to finance its investments/operations and how well it can manage the debt obligation. Obviously, if the company is unable to repay its debt or make timely payments of interest, it will be forced into bankruptcy. On the positive side, use of debt is beneficial as it provides valuable tax benefits to the firm. Note total debt should include both short-term debt (bank advances + current portion of long-term debt) and long-term debt (such as bonds, leases, and notes payable). (Prof. Phill Russeil, 2003).

Asset-Equity Ratio or Leverage Ratio= Assets/Shareholder's Equity

This shows firm's reliance on external debt for financing (or the degree of leverage). Any number above 100% shows that the company relies on external debt for financing some of its assets. If the number equals 100%, it implies that the assets are fully financed by the shareholders.

Some analysts tend to use the Debt ratio (given by total Debt/total assets) or Debt/Equity ratio given by total long-term debt/equity). These ratios also show company's reliance on external sources for financing its assets. (Prof. Phill Russeil, 2003)

1. Total Debt ratio = Total Debt/Total assets

2. Debt-Equity Ratio = Total Debt/Equity

3. Long-term Debt to capital = Debt/Debt + Equity

For a lender, more important than the degree of leverage is the firm's ability to service the debt and this is captured in the following ratio.

2 4 3 Analyzing Sales and Profitability

Profitability is a relative term. It is hard to say «what percentage of profits» represents a profitable firm as the profits will depend on the product life cycle, competitive conditions in the market, borrowing costs, expense management. Analysts will be interested in the (historical and forecasted), the set of ratios here include some of the traditional earnings based performance

measures such as ROS, ROA, ROI, and ROE. For a better understanding of growth rates, it will be useful to know the «real growth rate» as opposed to «nominal growth rate». For example, it is quite possible that the sales growth rate figures are impressive due to inflation (rather than an increase in the number of items sold). (Prof. Phill Russeil, 2003).

The following are ratios selected to analyse profitability and sales ;

1. Sales Growth Rate = {(Current year sales - last year sales)/last year sales} * 100

2. Expense analysis = various expenses /Sales

3. Gross Margin/Sales = Gross Profit/Total Sales

4. Operating Profit/Sales = Operating Profit/Net Sales

5. EBIT to Sales = EBIT/Net Sales

6. Return on Sales (ROS) or net profit ratio = Net Income/Net Sales

7. Return on Investment (ROI) = Net Income/Total Assets

8. Return on Assets (ROA) = Net Income/Total Assets

9. Return on Equity (ROE) = EAT/Shareholders' Equity

10. Payout ratio = Cash Dividends/ Net Income

11. Retention ratio = Retained Earnings/Net Income

12. Sustainable growth rate (SGR)= ROE * Retention Ratio

It is useful to disaggregate the ROE figure into three elements as follows to get a better insight 13 ROE = {Net Income/Sales} * {Sales/Assets} * (Assets/Equity)

The above formulation clearly shows that if management wishes to improve their ROE, they need to improve profitability, efficiently use the assets, and optimize the use of debt in their capital structure.

SGR shows how much the company will grow in the future if some of the key ratios remain the same as in previous years. It is useful to disaggregate the sustainable growth rate (SGR) as follows.

? SGR = f (Profitability, Asset Efficiency, Leverage, Dividend policy)

· SGR = Return on Sales * Asset turnover ratio * Leverage * Retention ratio

· SGR= (Net income/sales) * (sales/assets) * (assets/equity) * (RE/net income)

2 4 4 Analyzing Efficiency

These ratios reflect how well the firm's assets are being managed. The inventory ratios show how fast the inventory is being produced and sold. Ratio #1 shows how quickly the inventory is being turned over (or sold) to generate sales higher ratio implies the firm is more efficient in managing inventories by minimizing the investment in inventories. Thus a ratio of 12 would mean that the inventory turns over 12 times or the average inventory is sold in a month. Some High ratio by itself does not mean high level of efficiency as high ratio could also mean shortage. Ratio #2 is referred to as the «shelf-life» i.e. how many days the inventory was held in the shelf. Ratio #3 shows how much sales the firm is generating for every currency unit of investment in assets, naturally, higher the better. However, note that this ratio is biased (as assets are listed at historical costs while sales are based on current prices). Ratios #4 and #5 show the firm's efficiency in collecting from credit sales. While a low ratio is good it could also mean that the firm is being very strict in its credit policy, which may drive away some customers. Ratios #6 and 7 focus on efficiency in making payments. (Prof. Phill Russeil, 2003)

1. Inventory Turnover = Cost of Goods Sold/Average Inventory

2. Days in Inventory = (Average Inventory/Cost of Sales)*365

3. As sets turnover = Net Sales/Total As sets

4. Receivables Turnover = Credit Sales/Accounts Receivables

5. Average Collection period = (Accounts Receivable/Net Sales)*3 65

6. Accounts Payable turnover = Purchases/Accounts Payable

7. Days AP outstanding = (Accounts Payable/Cost of Sales)*3 65

2.4.5 Multiple Discriminant Analysis

The use of MDA helps to consolidate the effect of a set of ratios by looking at a number of separate clues (ratios to sickness or failure).It would be more useful to combine the difference ratios into a single measure of the probability of sickness or failure (bankruptcy).

According to (Altman E., 1968: 589-609), as the first man to apply discriminant analysis in finance for studying bankruptcy, his study helped in identifying five ratios that were efficient in predicting bankruptcy.

The model was developed from a sample of 66 firms half of which went bankrupt. He derived the following discriminant function:

Z = 0.01 2X1+0.0 1 4X2+0.03 3X3+0,006X4+0.999X5 Z= discriminant function score of a firm;

1. X1= net working capital/total assets (%);

2. X2= retained earning/total assets (%);

3. X3= EBIT/total assets (%);

4. X4=market value of total equity/book value of debt (%);

5. X5= sales/total assets (times)

Alman, established a guideline Z score which can be used to classify firms as either financially sound a score above 2.675 or a headed towards bankruptcy a score below 2.675. The lower the score, the greater the like hood of bankruptcy and vice versa.

2.4.6 Trend Analysis

Using the past history of a firm for comparison is called trend analysis. By looking at the trend in a particular ratio, one sees whether that ratio is failing, rising, or remaining relatively constant. From this, a problem is detected or good management is observed. (Charles H.GIB SON, 1989: 123).

2.5 The Components of Decision Making 2.5.1 Decision environment

decision environment would include all possible information, all of it accurate, and every possible alternative.

However, both information and alternatives are constrained because the time and effort to gain information or identify alternatives are limited (Robert Version, 1998).

2.5.2 Decision Model

Decision model can be used to represent a productive system in mathematical terms. A decision model is expressed in terms of performance measures, constraints, and decision variables. The purpose of such a model is to find optimal or satisfactory values of decision variables which improve systems performance within the applicable constraints. These models can then help guide management decision making. (ROGER G. SCHROEDER, 1985: 7).

2.5.2.1. The effects of using a decision model

A decision model has great impact on the profits of the company. It forces the management to rationalize the depreciation, inventory and inflation policies. It warns the management against impending crises and problems in the company. It specially helps in following areas:

- The management knows exactly how much credit it could take, for how long (for which maturities) and in which interest rate. It has been proved that without proper feedback, managers tend to take too much credit and burden the cash flow of their companies.

- A decision model allows for careful financial planning and tax planning. Profits go up, non cash outlays are controlled, tax liabilities are minimized and cash flows are maintained positive throughout.

- As a result of all the above effects the value of the company grows and its shares appreciate.

The decision model is an integral part of financial management. It is completely compatible with financial ratios analysis and derives all the data that it needs from information extant in the financial statements of the company.

2.6 Uses and limitations of Ratio Analysis 2.6.1 Uses

· To evaluate performance (compared to previous years);

· To set benchmarks or standards for performance;

· To highlight areas those need to be improved or highlight areas that offer the most promising future potential;

· To enable external parties (such as investors/lenders) in assessing the creditworthiness/profitability of the firm.

2.6.2 Limitations

· There is considerable subjectivity involved as there is no theory as to what should be the «right» number for the various ratios. Further, it is hard to reach a definite conclusion when some of the ratios are favourable and some are unfavourable.

· Ratios may not be strictly comparable for different firms due to a variety of factors such as different accounting practices, different fiscal year.

· Ratios are based on financial statements that reflect the past and not the future. Unless the ratios are stable, one cannot make reasonable projections about the future trend.

· Financial statements provide an assessment of the costs and not value. For example, the market value of items may be very different from the cost figure given in the balance sheet.

· Financial statements do not include all items. For example, it is hard to put a value on human capital (such as management expertise).

· Accounting standards and practices vary across countries and thus hamper meaningful global comparisons.

CHAPITER III
METHODOLOGY

3 0 Introduction

This chapter explains methods and instruments used to collect, analyze and to test the hypothesis the use of accounting ratios guides management as an effective tool in decision making.(Kenneth R. HOOVER, 1988: 33) says «the scientific method is the method that seeks to test thoughts against reality in a disciplined manner with each step in the process made explicit». This section covers the methods that the researcher is going to use to obtain the necessary data to achieve the objective and to come up with a suitable conclusion.

3 1 Research Design

Research design refers to outline, plan or strategy specifying the procedure to be used in investigating the research problem. (Christensen, 1991: 269). In the due course the researcher collects relevant data needed to test the researcher hypothesis. The design of the study is analytical in nature.

3 1 1 The analytical research

According to (Jill and Roger Hussey, 1997: 11) the analytical research design is continuation of the descriptive research. The researcher goes beyond merely describing the characteristics to analyzing and explaining why and how it is happening. Thus, this research aims to understand the use of accounting ratios by measuring causal relation among them in decision making.

In this study the researcher adopted a case study approach, where by AMAZI YA HUYE was particularly chosen. According to (CHRISTENSEN, 1991: 92), a case study is an intensive description and analysis of single individual, organization or event, based on information obtained from a variety of sources. It is in this regard AMAZI YA HUYE was chosen because the researcher was interested in manufacturing enterprises.

3 2 Population of the Study

As (Grinnell and Williams, 1990: 118), put it that, «a population can be defined as the totality of persons or objects with which a study is concerned». The population was comprised sorely the staff managers and accountant of AMAZI YA HUYE, financial statements and other records available of the 5 year period, which are from 2003-2007.

Table 3 1 Total population of Management and Accounting departments of AMAZI YA HUYE Description Population Sample selected Technique used Basic for

selection

Managers 2 1 Accountants 4 3 Cashier 3 2	Universal		The selection of the population was based on the role of each personnel plays in decision making	Total 9 6

Source: Primary data 3 3 Sources of Data

Data source refers to any material consulted or used in the due course of the study. Both the primary and secondary data were used in the study.

3 3 1 Primary Data

As put forward by (HAGOOD and PRICE, 1952: 20) «if a person or agency that has published data has earlier been collected or supervised the collection of data, the publication is called a primary source.» (Audrey et al, 1989: 57) adds that «primary sources come straight from people or workers you are researching and therefore the most direct kind of information you can

collect». That is the reason why primary data were first hand gathered by the researcher himself as a result of the researcher's investigation.

3 3 2 Secondary Data

Roth further states that these are one step removed from the original and are often an examination of a study someone else has made on a subject or an evaluation of commentary, or summary of primary materials, journal articles, critical reviews are the most common secondary sources.

The secondary sources of data for this study included financial statements, company records, internet publications, library books and memoires.

3 4 Data Collection Techniques

Documentary review (library, internet search and financial statement) was used to collect secondary data while primary data was obtained through interview guide

3 4 1 Documentary Review

A number of documents available in the library, on the internet, memoires and financial statements of the company chosen as a case study, were consulted for the purpose of obtaining secondary information relevant to the subject matter.

3 4 2 Document Analysis

(Paige Wilson, 1989:3) stated that a document analysis «is a system which formally acknowledges the sources consulted for researcher». The document review was based on the consultation of the company's annual reports, journal and other documents. The researcher used the balance sheets and income statements of the five year period to analyze, interpret and comment on different types of accounting ratios. The advantage of this method is that the researcher got useful information about the company's financial health which would be difficult to acquire using other instruments

3 4 3 Interview Guide

This technique involves exchange of ideas between the interviewer (researcher) and the interviewee (managers) to get the opinion of the interviewee on the use of accounting ratios in decision making. During the course of interview, notes were taken after asking questions on any information relevant to the study by the interviewer.

3 4 4 Sample size and selection

According to (William G. Cochran, 1997: 126) a sample is a part of population which is deliberately selected for the purpose of investigation. For our case study, the sample size is 6 people. The researcher selected two respondents from the top management and four from financial executives. The researcher chooses them because they are only respondents who can provide relevant information concerning the use of accounting ratios n decision making (AMAZI YA HUYE as the case of the study).

3 5 Sampling technique

The sampling technique that the researcher will use in this study is universal sampling. According to (Richard & Margaret, 1990: 125) «Universal sampling refers to the selection of sample where not all the people in the population have the same profitability of being included in the sample and each one of them, the probability of being selected is unknown.

The researcher preferred to use universal sampling technique to select respondents from the top management and finance department because they are the ones who may provide the useful information to test the hypothesis of this research.

3 6 Data processing and analysis

(Nachimias D. and Nichimias C., 1976: 143) argue that «data processing and analysis involves the transformation of data gathered from the field into a systematic categories and the transformation of these categories into codes to enable quantitative analysis and tabulation; the data collected was classified into a meaningful manner for easy interpretation and understanding.

This involves preparing data collected into some useful, clear and understandable data. The whole exercise involved calculations of different types of ratios to analyze, liquidity, debt, efficiency, sales and profitability, compute the trend analysis and the multiple discriminant analysis for the secondary sources.

While for the first hand information the researcher has summarized the recorded interview (discussion).

3 7 Study limitations

Some limitations were encountered during the process of data collection; however salutation were sought in order to make the findings of the study available as planned. The following are the limitations that were encountered:

· Financial constraints as funds provided by the National University for the research were delayed.

· Access to the financial statements of companies in Rwanda is not easy Solutions to the above limitations:

· The researcher has to borrow funds from friends and ask support to his family members in order to accomplish the research in time

· A letter of authorization from the university was used by the researcher as evidence to the management staff of AMAZI YA HUYE to prove that the research is conducted for the academic purpose

CHAPTER IV

DATA ANALYSIS AND INTERPRETATION

4 1 Introduction

This chapter presents the findings of the study entitled «the use of accounting ratios in decision making» in AMAZI YA HUYE. It also presents a brief description of AMAZI YA HUYE as the case study. It also based on the analysis of both primary and secondary data collected to achieve the stated objectives. The analysis of the data collected was done in accordance with the study objectives and hypothesis. The results were reported in tables and summarizing answers to major questions asked. The researcher used focus group interview to obtain first hand information, whereby all six staff of the company who deal with accounting and finance were involved in the discussion. In short, this chapter examines the empirical evidence and establishes grounds upon which the researcher hypothesis can be proved before concluding the results of this research.

4 2 The Profile of AMAZI YA HUYE

AMAZI YA HUYE is a private company that was formed in 1998, with the key aim of mineral water production and its base is in Huye District former Butare town in the Southern Province.

Their first mineral water product appeared at the market beginning with the year 2000, after the scientific laboratory experiment by the University of Shanghai in china. Experts from this University confirmed the purity of the mineral water manufactured by AMAZI YA HUYE enterprise

AMAZI YA HUYE Company do not only produce mineral water but also produces the plastic bottles into which their mineral water products are packed.

4 1 2 AMAZI YA HUYE location

Its head office is in Kigali city at Muhima near Kabuga's building because of availability of large market. This company still sells its products locally but it imports its raw materials abroad specifically from China.

4 3 AMAZI YA HUYE's mission

It seeks to increase the productive capacity of the mineral water and play a key role in transforming the economy and enhancing the well being of people. Through their dynamic and responsive teams, it aims at providing the products and maintains the highest levels of customer service and professional integrity.

4 4 AMAZI YA HUYE's objectives

> To support the development of the industrial sector generally through innovative and the transfer international best practice.

> To support the drive of the private sector investment for the development of the economy working with locals as well as international investment and development focused agencies.

> To meet needs and expectations of its customers by providing the products at the right quality and at the right time.

4 5 The environment of AMAZI YA HUYE

The AMAZI YA HUYE Company is not a monopoly one but operates with a perfect competition market structure.

In order to adapt itself to the business investment, this enterprise makes sure that it has a good relationship with the commercial banks and even other industries operating in Rwandan territory and other countries.

4 6 Juridical statute of AMAZI YA HUYE

AMAZI YA HUYE enterprise is an individual Industrial company of Mr. GAKWAYA Etienne whose capital was 83,404,822 RWF at the beginning in 1998 but currently the capital is 149,000,000 RWF

Figure 4 1 Organization structure of AMAZI YA HUYE

Executive Director



Director of commerce



IT Manager				Chief Accountant		Importation Officer		Engineer
		Human Resou rce manager



Accountant A		Acco unta nt				Secretary		Cashier
				Acco unta nt



Manpower		Drivers		Officer messengers

Source: Marketing Department of AMAZI YA HUYE. 4 7 Tasks description

By making description of the above organization structure, different tasks attributed to general management and different departmental services are precised in accordance to the organizational arrangement of the chart.

A. Executive Director

The executive director of AMAZI YA HUYE is responsible for taking all the dec isions relating to effective management and policy formulation of the enterprise. He is also in charge of the following activities:

- To insure the coordination and management of different department like commercial service, production service and financial service.

B. Director of commerce

This one is responsible for the evolution of commercial and marketing services and making survey on the areas of competition. He takes measures on the quality and quantity of mineral water to be taken to the market, he makes follow-up on the buying and the selling conditions, for the interest of the clients.

Sometimes he proceeds to the ground to investigate the consumers perception upon certain decisions under took and these assist him to underlay appropriate strategies.

C. Human resource manager

The human resource manager is in charge of recruitment of the employees and makes sure that the recruited employees are ones with competent skills which can lead to the general improvement of the company' s performances.

He assigns duties and responsibilities to the employees and makes supervisions to different department to approve if the delegation of power is respected by departments.

He posses power to appoint and dismiss misbehaved workers after his consent with the executive director.

D. Accounting department

The responsibilities of this department are as follows:

- Keeping records of the day to day business transactions

- Preparation of the financial statements of the company

- Keeping the books of accounts like the journals, ledgers and trial balance.

- Recording the daily operations of expenses and revenues of the company of AMAZI YA HUYE

- Analyzing financial transactions and gives information to the management and the third parties.

- Advising the top management on the financial position and decision making.

E. Importation officer The importation officer has the following key duties:

- He makes sure that all the logistical and procurement services are done smoothly with in the enterprise.

- Importation of required technical instruments to run enterprise's daily production affairs. - Monitoring on the quality of production basing on capacity of machines.

F. Engineer The responsibilities of an engineer include:

- Rendering mechanical services at any time when technical errors happen. - Repairing of machines that have experienced technical problems.

- Control and measures the electricity used by the company.

G. IT Manager: This one has got the following tasks

- System soft ware in the company

- Distribution of information system in all the departments - Repair of computers that are experiencing errors.

4 8 Data analysis

has been a result of a number of factors, but the main factor is a lack of rational decision making. As finalist student in Accounting Sciences in this research, we picked interest in one of techniques that is commonly used in decision making since it naturally provides much information in almost every aspect of the business. The researcher was motivated to find out the effectiveness of using accounting ratios in decision making of the enterprise. The student was also interested in knowing whether this techniques is used or not, and what could be the requirement to use them effectively.

4 8 1 In depth Interview

To the opinion of the accountant and management department executives on important issues related to accounting ratios group interview (in depth interview) was conducted. All six staff of management department in AMAZI YA HUYE was interviewed including the accountants of this enterprise

The discussion took place at AMAZI YA HUYE headquarter as well as at the factory residence whereby all the participants were requested to think on all matters concerning accounting ratios in AMAZI YA HUYE. After each interview, notes are taken to unable analysis to be made. For some question clarifications are given to the interviewee so that they can give their views and opinions.

The discussion was designated to accomplish the following objectives:

1. To identify the importance of using accounting ratios in decision making

2. To know whether accounting ratios are used in AMAZI YA HUYE

3. To determine the linkage between accounting ratios and decision made in AMAZI YA HUYE

4. To determine other factors used in decision making

5. To identify the constraints that hinder the proper use of accounting ratios

4 8 2 Type of ratios used

For this purpose 32 ratios were selected based upon a review of text books. These ratios were divided into 5 categories of analysis, such as ratios to use in analyzing liquidity, efficiency, sales profitability, debt, and in multiple dicsriminant analysis. The management staff of AMAZI YA HUYE disclosed that ratios are frequently used by the company in analyzing profitability and liquidity. They said that ratios used in this manner are more significant to take any decision.

After knowing that accounting ratios are used in AMAZI YA HUYE as a tool of analysis in decision making and after knowing that the staff management of AMAZI YA HUYE are interested in their use in decision making the researcher wanted to investigate how this technique is used.

4 8 3 Preferred ratios in decision making

To determine the preferred ratios the researcher asked the following question» What among the following kind of accounting ratios do you take into account while making decisions and for which purpose?»

· Liquidity ratios

· Debt ratios

· Efficiency ratios

· Sales and profitability ratios

One of the respondent said that while analyzing liquidity position liquidity ratios are used, in analyzing efficiency of the company inven tory turnover ratio is used and some ratios are used especially in analyzing sales and profitability.

4 8 3 1 Preferred ratios in analyzing liquidity

Basing on the review of text books, the researcher chose the following ratios in analyzing liquidity:


· Current ratio

· Quick ratio (acid test ratio)

· Cash ratio

As said in the above response these ratio are used in analyzing liquidity position of the company. One of the managing explained that the use of this kind of ratios presents an importance to the company because it helps to know the level at which the company can pay its short term debts.

4 8 3 2 Preferred ratios in analyzing efficiency

Concerning efficiency ratios, the researcher chose some of them basing on the review of text books. Following are some of these ratios:

· Inventory Turnover

· Days in Inventory

· Assets turnover

· Receivables Turnover

· Average Collection period

· Accounts Payable turnover

· Days AP outstanding

The management staff showed much interest in efficiency ratios, one of them said,» efficiency measuring is very important for any business», He went on commenting that, the efficiency ratios can help to adjust the inventory to sales collection using inventory turnover, days in inventory. Most of them had the same views but the put emphasize on profitability ratios by saying, «When a company is profitable it means that it is efficiently performing its operations».

4.9.3.3 Preferred ratios in analyzing debt

Basing on the review of text books, the researcher chose the following set of ratios to analyse debts of our case study.


· Total Debt ratio

· Debt-Equity Ratio

· Long-term Debt to capital

· Asset-Equity Ratio or Leverage Ratio

One of the management staff said that debt ratio help to measure the extent to which a company rely on outsiders funds.

4 10 Accounting ratios and decision making

To determine whether there exists a linkage between accounting ratios and organization sustainable growth, the researcher asked the following question to the respondents «Do you agree that, the use of accounting ratios can lead to the decision making?» The following table shows categories of their responses:

Table 4 1 Respondents' view on the linkage between accounting ratios and decision making

Personnel

Responses

Agree 3

Disagree 1

Neutral 2

Source: Primary data

There seems to be a majority who agree that there is a linkage between accounting ratios and decision making. The chef accountant commented that decision model like financial ratios plays a great role in assessing the financial performance of the company but he presented the problem of a lack of capacity to use them. One of the accounting department said, though financial ratio analysis is not the only measure of performance, still it is the best to measure the financial health of the company to take any decision.

added that this tool is as important as accounting ratio. The researcher asked which purpose the have while using this method; he replied that the use a flexible budget since it gives room for any change in the future.

Another participant added that in AMAZI YA HUYE they put more emphasize on the importance of preparing budget for each cots center. The researcher wanted to know different kinds of budget prepared there, one of the respondent said, here we prepare various budget like purchase budget, sales budget, production budget, selling and distribution budget.The remaining participant didn't to have any comment because she said that her task have no linkage with decisions taken in the company because she is a book keeper.

The researcher if there are any techniques used to make decisions that avoid bankruptcy as it had occurred to SORWAL SARL, among this type of analysis the researcher presented them a set of significant ratios used in the multiple discriminant analysis. The manager officer said, this could be the effective tool to take decision for avoiding bankruptcy but he added that is not yet used in their company. He concluded by saying that, what is important is to use the accounting ratios as a decision model effectively, but he insisted saying that the problem related with such use is a lack of skilled people in this area.

4 11 Analysis of accounting ratio as a decision model

The secondary data also are used as source of information of a part of the analytical research, for this reason, financial statements of five consecutive years of AMAZI YA HUYE are used, that is from 2003 to 2007. The following analysis was done basing on the secondary data

4 11 1 Liquidity analysis

The table below presents the trend of liquidity position of the company as far as current, quick and cash ratios are concerned, from 2003-2007.

Table 4 2 Trend of liquidity ratios

	Formula	2003	2004	2005	2006	2007
RATIOS
Current ratio	Current asset/current liabilities	0.98	1.01	0.99	1.36	2.27
	Current asset-Inventory/current
Acid test ratio	liabilities	0.59	0.34	0.37	0.73	1.51
	Cash+ Marketable
Cash ratio	securities/Current liabilities	0.47	0.28	0.32	0.52	1.17

Source: Computed from secondary data Ratio interpretations

We compare the results of the current ratio basing on the standard ratio 2: 1. As far as the current ratio is concerned, it was 0.98:1 in 2003 that is not satisfactory even for three successive years of 2004, 2005 and 2006 the ratio computation is 1.01, 0.99.1.36 respectively, for this case the liquidity position went down below the standard but in 2007, the ratio was satisfactory as it was above the standard 2:1, as it was 2.27:1.

Compared to the standard of 1:1 the quick ratio of the company shows unsatisfactory situation from 2003 till 2006, as in 2003 it was 0.59:1, in 2004 it was 0.34, in 2005 it was 0.37:1 and in 2006 it was 0.73 :1. Since 2007 the ratio became satisfactory as its result was 1.51:1.

As far as the cash ratio is concerned, it is 0.47:1 in 2003, 0.28: 1 in 2004, 0.37:1 in 2005, 0.52:1 in 2006 and 1.17:1 in 2007. Basing on the standard of 0.5: 1, the result of this ratio shows unsatisfactory case in 2003, 2004 and 2005. But in 2006 and 2007 there is a satisfactory situation of liquidity as the ratio computation is 0.52:1 in 2006, 1.17:1 in 2007, what we can also include to the result of 2007 is that there is a portion of idle resources of 0.17.

Figure 4 2 AMAZI YA HUYE Liquidity ratios 2003 - 2007



RATIOS

Time years

Comments

As the table 4 3 and fig 4 1 show, the company' liquidity ratios exbhit a diclining pattern from 2003 to 2005 basing on the rule of thumb.As shown by the above figure, the cuurent ratio, quick ratio, and the cash ratio dropped from the recommendable ratio in 2003,2004 and 2005 as per the role of thumb, 2:1 to current ratio, 1:1 to quick ratio, 0.5:1 to cash ratio, that prove the less liquidity to meet the short term obligations, basing on the above analysis, in 2003, and 2005 the company has no working capital even in 2004 it was not interesting. The situation got change in 2006 and get improvement in 2007 when the results shows the figures above the recommendable ratio.

4 11 2 Debt analysis

The following table indicates the trend of Debt ratios in AMAZI YA HUYE for the period of our research that is 2003 - 2007.

Table 4 3 Trend of debt ratios

	Formula	2003	2004	2005	2006	2007
RATIOS
Leverage ratios	Assets/Shareholder's equity	2.12	1.83	2.22	1.75	1.35
Total debt ratio	Total debt/total asset	0.52	0.45	0.53	0.42	0.26
Debt to equity ratio	Total debt/equity	1.12	0.84	1.13	0.75	0.35
Long term debt to capital	Debt/Debt Equity	0.52	0.45	0.53	0.42	0.26
Interest coverage ratio	EBIT/Annual interest expenses	0.53	0.46	0.53	0.43	0.26

Source: Computed from secondary data Ratio interpretation

The total debt ratio indicates the extent to which the firm is using debt to finance its assets. The better when the ratio is 0.5:1 or less. In 2003 the ratio was 0.53:1, in 2004 it declined to 0.45:1, in 2005 it got increase to 0.53:1, in 2006 it deceased when it was 0.42 and in 2007 it was 0.26:1.

The result of debt to equity ratio indicates the relationship between lenders' contribution for each franc of the owners' contribution. It in this case, the lenders have contributed more in 2006 for 1 franc given by the owners the lenders give 1.12, and in 2005 for 1 franc from owners the lenders provide 1.13. For the other periods the situation was good as in 2004 for one franc from the owners, lenders provide 0.84, in 2006 for 1 franc from the owner, lenders provide 0.75, and in 2007 for 1 franc from the owners, lenders provide 0.35.

The total leverage ratio relates total as sets to shareholders `equity. This ratio is a degree to which
management has financed the company's asset investment with no ownership capital. The result
of the leverage ratio computation for AMAZI YA HUYE reveals the following situation: in 2003

the ratio was 2.21 which means, to 1 franc from owners 1.12 has been used to find the company's assets from outsiders, in 2004 the ratio was 1.83, to 1 franc from owners, outsiders provide 0.83 to fund the company's assets, in 2005 the ratio was 2.22, to 1 franc from owners, outsiders provide 1.22 to fund the company's assets, in 2006 the ratio was 0.75, to 1 franc from owners the outsiders provide 0.75, in 2007 the ratio was 0.32, to 1 franc from owners the outsiders provide 0.32.

Figure 4 3 AMAZI YA HUYE debt ratios 2003 - 2007



RATIOS

Time in years

Comments

The debt ratios generate the company's ability to meet its obligations, otherwise it measures the dependability of the company to the outsiders. Basing on the ratio computation in table 4 3 and its representation in figure 4.3, in 2003 there was an increase in dependability of the company to the outsiders funds, it declined in 2004, but in 2005 it increased which means that in this period the claims of creditors were greater than those of owners. Starting to 2006 till 2007 these ratios were trending downward, for this reason, the dependability to the outsiders declined which shows a good sign of solvency of the company.

4 11 3 Sales and profitability analysis

The table below shows the sales and profitability of AMAZI YA HUYE for the period covering five successive years, that is to say 2003 - 2007.

Table 4 4 Trend of sales and profitability ratios

RATIOS	Formula	2003	2004	2005	2006	2007
Sales growth	(current year sales-last year
rate	sales)/last year sales)*100	0.00%	15.00%	-7.2%	-32.04%	-1.21%
Expenses analysis	Various expenses/Sales	0.52	0.74	0.75	0.70	0.51
Gross margin to sales	Gross profit/ Total sales	0.42	0.23	0.21	0.24	0.42
Operating profit to sales	Operating profit / Sales	0.08	0.04	0.05	0.09	0.10
EBIT to Sales	EBIT/ Net sales	0.08	0.04	0.05	0.09	0.10
Return on sales	Net income / Net sales	0.06	0.03	0.04	0.06	0.07
Return on investment	Net income / Fixed assets	1.75	1.94	1.67	1.47	1.84
Return on assets	Net income / Total assets	0.83	1.05	0.79	0.60	0.77
Return on equity	EAT /Shareholder's equity	0.09	0.58	0.06	0.07	0.07
Payout ratio	Cash dividend /Net income	0.00	0.00	0.00	0.00	0.00
Retention ratio	Retained earring/ Net income	0.01	0.01	0.01	0.01	0.01
Sustainable growth rate	REO*Retention ratio	0.0500	0.0175	0.0021	0.0040	0.0045

Source: Computed from secondary data Ratio interpretation

The sales growth rate was 0.0 in 2003 as there is no data given for the previous. Basing on 2003 in 2004 there was growth of 15%, in 2005 comparing to 2004 there was growth of 7.20%, in 2006 basing on 2005 sales there was growth of -32.04%, and in 2007 there is growth of -1.12% of sales. The results obtained shows that in 2006 the sales declined with a great percentage which

follows buy a bit decline in 2007 all of these situations involve the reinforcements of the marketing activities of the company to ensure a sustainable growth.

The gross margin to sales ratio is an indication of the management's ability to mark up its products over their cost. In 2003 the ratio was 0.42 that means to 1 unit sold the cost of product sold was 0.58, 2004 it was 0.23 that means to 1 unit sold 0.77 was the cost of product sold, in 2005 it was 0.21 that means to 1 unit sold 0.79 was cost of goods sold, in 2006 the ratio was 0.24 that means to 1 unit sold 0.76 was the cost of product sold, in 2007 the ratio was 0.42 that means to 1 unit sold the cost of product was 0.58.

The expense analysis ratio shows the rate of expenses incurred after each sale. It helps to control the expenses comparing to the rate of margin to sales. The result of this ratio was 0.52 in 2003, in 2004 it was 0.74, in 2005 it was 0.75, in 2006 it was 0.70 and in 2007 it was 0.51.

The return on sales indicates the relationship between sales and the earning of the period. It helps in controlling expenses with the rate of margin. In 2003 the ratio was 0.06, in 2004 it was 0.03, in 2004 the ratio was 0.04, in 2005 it was 0.06, and in 2007 it indicates 0.07.

The return on assets ratio shows the relationship between total assets and sales realized. The trend of this ratio in AMAZI YAHUYE indicates that in 2003 for 1 franc invested in fixed and current assets the return is 0.83 on sales, in 2004 for 1 franc invested in fixed and current assets the return is 1.05 on sales, in 2005 for 1 franc invested in fixed and current assets the return is 0.79on sales, in 2006 for 1 franc invested in fixed and current assets the return is 0.60 on sales, in 2007 for 1 franc invested in fixed and current assets the return is 0.77 on sales.

The trend of return on investment helps to analyze the income earned and capital employed. In 2003 to generate 1 franc in sales the company invested 1.75 in fixed assets , in 2004 to earn 1 franc in sales the company invested 1.94 in fixed assets, in 2005 to generate 1 franc in sales the company invested 1.67 , in 2006 to earn 1 franc in sales the company 1.47 , in 2007 to generate 1 franc in sales the company invested 1.84.

The return on equity indicates how well the company has used the owners's resources. In our
case study, the result of this ratio was 0.09 in 2003, 0.058 in 2004, 0.06 in 2005, and 0.07 in
2006 and in 2007. The percentage of this ratio reveals the relative performance and strength of

the company in attracting future investments; it means that in 2003 the capacity of AMAZI YA HUYE was too high comparing to the following years when it declined slightly till the level of 7% in 2007.

Figure 4 4 AMAZI YA HUYE expenses analysis, gross margin to sales, return on sales ratios
2003-200 7



RATIOS

Time in years

Comments

Basing on the results from the table 4 4, from 2003 to 2006, there was a decrease of gross margin ratio, but on the other side there was an increase in expenses as shown in expenses analysis ratio. This situation leads to the reduction of net profit regarding these periods that means there is no expenses management basing on sales and cost of goods sold. This set of ratio can help to take measures for the future sales and their expenses. In 2007, we consider a slight decrease of gross profit margin, as well as a slight increase in expenses analysis ratio which provide a bit higher return on sales ratios comparing to the previous periods.

The above comments are depicted in the figure 4 4 that represents together gross profit margin ratio, expenses analysis ratio, and return on sales ratio of AMAZI YA HUYE from 2003 to 2007. In 2003-2005 the expenses curve was upward sloping comparing to the gross profit curve that was down ward sloping in 2006-2007 the expense curve changed, it was down ward sloping, comparing to the gross profit curve that was up ward sloping. These situations make an impact on the net profit of the company that could be greater in 2003-2005, but the expenses became uncontrollable comparing to the margin of cost of raw material to sales realized in that time, in the following two years, the expenses management was controlled basing on cost of raw material

to sales, the reason the sales turnover was lower than the previous years but the net profit was somehow closer to those of these periods even the sales turnover of these periods was higher (2003, 2004 and 2005).

4 11 4 Efficiency analysis

The table below shows the trend of the efficiency ratios of AMAZI YA HUYE from 2003 - 2004.

Table 4 5 Trend of efficiency ratios

RATIOS	Formula	2003	2004	2005	2006	2007
Inventory	Cost of Goods Sold/Average
turnover	Inventory	8.9	8.93	8	7.8	8.73
Days in	(Average Inventory/Cost of
inventory	Sales)*365	41 days	41 days	46 days	46 days	42days
Asset turnover	Net Sales/Total Assets	0.83	1.5	0.85	0.6	0.72
Receivables turnover	Credit Sales/Accounts Receivables	12.7	30.1	23.5	4.4	5.13
Average collection	(Accounts Receivable/Net
period	Sales)*365	28 days	12 days	16days	83 days	71days
Accounts ayable turnover	Purchases/Accounts Payable	1.98	1.8	1.32	0.83	1 29
Days AP	(Accounts Payable/Cost of	325	183	274	435	282
outstanding	Sales) *365	days	days	days	days	days

Source: Computed from secondary data Ratio interpretation

The trend of inventory turnover shows how rapidly the inventory into receivable through sales. In 2003 the ratio was 8.9 that is to say 41 days the raw material remain outstanding, in 2004 the ratio was 8.93 so the stock of raw material remain outstanding for 41 days, in 2006 the ratio was 8 it means that the stock of raw material remain outstanding for 42 days, in 2007 7.8 that is to say 42 days that the stock of raw material remain outstanding.



RATIOS

Time in years

The trend of receivables (debtors) turnover measures the quality of debtors since it indicates the speed of their collection. Its interpenetration is combined together with the result of average collection period. In AMAZI YA HUYE in 2003 this ratio was 12.3 that means 20 days that the book debts remains outstanding, in 2004 the ratio was 30.1 which means 10 days that book debts remains outstanding, in 2005 the ratio was 23.5 which means 13 days that the book debts remains outstanding, in 2006 the ratio was 4.4 that means 55 days that the book debts remains outstanding, in 2007 the ratio was 5.13 that means 42 days that the book debts remains outstanding.

Looking on the trend of accounts receivable turnover ratios in days from 2003 to 2004, we can see that accounts receivable are well managed at AMAZI YA HUYE as there is an downward trend from 325 days in 2004 to 183 days in 2005 the rend became upward a bit till 274 days but the situation changed in 2006 when the trend reached 435 days, this is so because the late payment on behalf of debtors leads the firm to the lack of liquidity to pay its liabilities on due time, in 2007 the trend indicated an downward trend from 435 days to 282 this situation became so as the company' s liquidity ratio reached an interesting level

Figure 4 5 AMAZI YA HUYE receivables and payables turnover ratios 2003-200 7

From the above table 4 5 and fig 4 4, keeping in mind that creditors are source of funds and debtors (receivables) are use of funds, although AMAZI YA HUYE's receivables for the period of the study have generally been higher in figures than its creditors, the company benefited by collecting receivables before paying its creditors since 2003 till 2007. It should be noted that creditors are an interest -free form of financing called, this is a spontaneous sources of financing.

The collection period in 2003-2005 was not so long and in 2006-2007 it become long a bit, comparing to the days that payables remain outstanding, the company should take advantage of the extended credit period to lengthen a bit the credit sales periods for undoubtiful customers to attract for instance the potential consumers for their products

4 11 5 Multiple discriminant analysis

Table 4 6 Trend of multiple discriminant analysis

RATIO	Formula	2003	2004	2005	2006	2007
Z	discriminant function score of a firm
X1	Net working capital/total assets (%)	-0.72%	-0.48%	-0.17%	15.50%	32.40%
X2	Retained earnings/total assets (%)	4.60%	3.20%	2.80%	3.70%	5.03%
X3	EBIT/total assets (%)	6.60%	4.45%	4.03%	5.34%	7.18%
	Market value of total equity/book value
X4	of debt (%)	88.80%	119.70%	88.63%	132.80%	282.90%
X5	Sales/total assets (times)	0.83	1.05	0.79	0.60	0.73
	0.01 2X1+0.0 14X2+0.033X3+0,006X4+
Z	0.999X5	1.64	1.96	1.49	1.81	3.12

Source: Computed from secondary data The MDA interpretation

The MDA as an academic study on the use of accounting ratios to forecast the financial failure, the management of each company can use it to take preventive measures to the bankruptcy. Firms also can use this model in making credit decisions and in monitoring receivables.

Basing on the standard, the higher of the Z score the better, and this score below 2.675 the risk to the company to go bankrupt. In our case study, in 2003, 2004, 2005, 2006 the company shows the sing of going bankrupt as the Z score as computed in the above table 4 6 was respectively, 1.64, 1.96, 1.49, 1.81 but in 2007 this situation change toward a level to which the financial sound of the company can't lead to the bankruptcy, as the Z score was above the standard, it was 3.12.

Figure 4 6 AMAZI YA HUYE Multiple Discriminant Analysis 2003-2007



Z score

Time in years

Comments

Looking at the Z measurement curve, the situation of AMAZI YA HUYE to go bankruptcy was too high in 2005, even in 2003, 2004 and 2006 also the level of AMAZI YA HUYE towards bankruptcy was remarkable. But in 2007, the situation changed as seen on the Z scored curve in 2007, so the management of AMAZI YA HUYE should take measures to maintain such situation by computing the MDA for each year the predict the financial failure.

4 12 Hypothesis testing

The study hypothesis stated that: The use of accounting ratios guides management as an effective tool in decision making. From the findings derived in this study, the researcher has enough evidence to confirm the hypothesis. Based on the responses of the personnel of the company in table 4 1 of this chapter, about respondent's view on the linkage between accounting ratios and decision making, it is clear that, there is majority who agree that, ratio analysis is a

vital tool in decision making. Also the analysis made from different kind of ratios computed using financial statements of AMAZI YA HUYE proved that the management stands the better to take decision by using accounting ratios rather than not.

Another hypothesis stated that: The result of using accounting ratios relies on the effectiveness of accounting and how accountants are skilled in financial analysis techniques. From the findings derived in this study, the researcher has obtained the testimony from the accountant that the use of accounting ratios can guide management, but there was hindrance presented of using this technique which is a lack of capacity to use them. Also this hypothesis is tested.

CHAPTER V

SUMMARY, CONLUSION AND RECOMMENDATIONS

5 1 Summary

Managers are responsible for the business health of their firms. It is their responsibility to avoid financial mistakes. The financial side of the business can be managed by the use of appropriate financial management strategies just as the physical side of the business is managed.

Financial ratios, which measure the relationship between two financial items or categories, are useful tools in this process. Ratios are like symptoms in that they do not tell you what is wrong, but rather guide your thinking and analysis into areas where problems may exist. They facilitate comparisons among unwieldy numbers, among various parts of the business as well as among different industry firms. When analyzed over time they can provide an early warning system to detect emerging trends in the financial condition of the business.

In the first chapter, the researcher tried to indicate the background of this study, the problem statement where the researcher tried to show how the no use of accounting ratio can mislead management of each company while depending solely on financial statements in decision making; at this level objectives of this study are stated as well as its hypothesis.

In the second chapter, the review of what other researcher have so far done in this area of accounting ratios and decision making has been given. Different views on ratios and decision making have been advanced and discussed to provide theories upon which hypothesis are tested,

In the third chapter, the methodology aspects adopted by the researcher in carrying out this research is defined. Study variable were determined, sampling techniques used were also discussed; data collection also was defined for this research to collect both primary and secondary data. Primary data were collected using interview as quantitative oriented research, secondary data were collected using financial statements of 5 years period 2003 - 2007.

In chap ter four, the findings obtained by the researcher were found basing on theories put forward by a number of researchers in chapter two. The use of accounting ratios can guide decision making. It is worth noting that, the use of accounting ratios can be effective if these ratios are carefully used but the problem is lack of capacity to use them. This has been confirmed by the accountant of the company of our case study.

For any business to prosper there is a need in decision making. It is in this view, the accounting ratios can be considered as a decision model, since they provide information from different aspects of the business. The more the management use accounting ratios, the better the chance it stands to guide dec ision making.

Finally, the findings enabled the researcher to test the hypothesis. Basing on the findings the researcher confirms all hypotheses stated.

5 2 Conclusion

Financial statement analysis involves analyzing the firm's financial statements to extract information that can facilitate decision-making. The use of accounting ratios as one of techniques used in financial statements analysis can guide management in decision making by playing a centre role in measuring the strength and weaknesses of the firm. Ratio analysis for a business enterprise like AMAZI YA HUYE centres its efforts to derive quantitative measures or guide concerning the expected capacity of the firm to meet its future financial obligations or expectations.

Based on findings, AMAZI YA HUYE does not give much significance in profitability ratios, the management staff of the company believe that, net profit margin ratio, not only displays the profitability of the company comparing to sales, but also the net profit ratio cans help in expenses management. Thus, according to them there is no need of using any of the profitability ratios.

right. It is observed that, others ratios like expenses analysis ratio and gross margin ratio play a great role to determine the profitability, as gross margin ratio decreases and the expenses analysis ratio increases the net profit ratio decreases. There is a strong relationship of these ratios to measure profitability of a company in order to control expenses within the income earned to take measures for the future financial expenses and revenues.

In addition to that, this study provides a method that can be used to predict the financial failure as called Multiple Discriminant Analysis. For our case study this model is not yet used but the researcher finds the great role that can play this model to help all business entity to survive in their economic environment.

Furthermore, it was found that, the accounting department has a problem of using accounting ratio even the personnel of this department accepts the effectiveness of using them, this is due to a lack of knowledge required for the use of accounting ratio. Basing on the discussion with the management staff, they accept the role that can play accounting ratios in decision making but they present a problem of lack of capacity to use them.

From the researcher' s point of view, decision making in AMAZI YA HUYE is effective, this is because of various reasons. First, the use the accounting packages used by the company facilitates decision making, whereby there is easy storage and access of data. Second, the use of some of accounting ratios and other model like the flexible budget can provide information from various aspects of business; all of these methods put the management in a better position in decision making. Therefore the combination of these qualities among others can ensure effective decision making.

However, the facts that AMAZI YA HUYE operates in the perfect competition market, decision making of the company can have the more value to survive in competitive market. In competitive market, for any firm to survive the competition, there is a need of effective decision making to ensure the efficiency. That is to say, the company should be vigilant on cost management and profit maximisation.

Finally, the study objectives were attained and the questions to be study were answered.

5 3 Recommendations

Based on the research findings, skills of the researcher and other constraints accounted, we can finish this work by giving the following recommendations that aimed at further improve dec ision making by the use of accounting ratios for the great success of AMAZI YA HUYE:

1. Since the profit of AMAZI YA HUYE seems to be the same based on the periods of this study, and this profit earned is obtained with different sales turnover, for a better understanding of performance and profitability in AMAZI YA HUYE, the company should calculate expenses analysis ratio, gross margin ratio and net profit ratio for each period covered. It is through this analysis that a company can be able to assess the expenses incurred comparing to sales realized and gross margin obtained for a better control of production cost and other expenses.

2. The company should improve its capacity to attract potential investors by calculating its return to equity ratio and compare it to the result of this ratio from the firms in same industry to test their ability to increase the equity even from the external resources that the company can benefit from potential investors.

3. The computation of multiple descriminat analysis should be made at the end of each accounting period to assess the historical data in order to predict the financial failure not for AMAZI YA HUYE as our case study, but also for the other business entity to verify their going concern situation.

4. The management of the company should look for the means of disclosing company's financial statement to the professional accountants in order to get advices and recommendations from these experts to get the fully disclosed financial statement on which financial analysis could be conducted in decision making

5. As in the country there is a lack of accounting regulations, the ICPAR should prompt their settings and train the academician accountants so that they can fill gaps of shortage of professional accountants in Rwanda.

5 6 Area for further research

Research on the role of budgeting control in decision making is encouraged because the budgeting control plays big role in quick decision making. Further research should be conducted on the stakeholders' perspective of accounting ratios.

Lastly, further research should also be done on the role of qualified accountants in decision making and the firm's performance.

48
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APPENDICES