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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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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.

iv

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

vi

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

ix
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

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