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The use of accounting ratios in decision making

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par Lambert KABERA
National University of Rwanda - Bachelor Degree 2009

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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.

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