CHAPTER ONE

INTRODUCTION

• 1. Background of the Study

Stakeholders always seek the existing order and understanding about the phenomena governed by laws governing their relationships and need to predict their behaviour. This kind of attitude toward access to integrated data collection was done to make better decisions considering to the high volume of raw data to create and develop the growing market need for investment in human societies use financial info always been led to intellectual challenges to provide useful information and good decision makers were and definitions and specific criteria for this data set. One of these cases, trying to balance between the discoveries of financial information has been using financial ratios decisions nineteenth century was formed, though before that “fit theory” was developed in the human sciences (Asghar, 2011).

It should also be noted that financial ratios have played an important role in the process of financial performance since 300 BC. During this period, Elucid was the first to bring out the properties of ratios in his book V. However, widespread usage of financial ratios could be traced to the 19^th century when America was approaching industrial maturity (Sanobar Anjum, 2011). But it is disturbing to observe that the Cameroon Baptist Convention overlooks this role in the 21^st century. In the 19^th century, there was the challenge as it is today of making decisions amidst of huge financial transactions. During this period, America transferred management into the hands of professional managers who then began to analyse financial statements vigorously using financial ratios for better decisions (Altman, 2011). At the beginning, credit analysis dominated the general development of ratios analysis, thus for one to understand the evolution of ratios, one must primarily look at credit analysis. Nevertheless, the development of ratio analysis took different paths in the mid-1940s. Emphasis was laid on the role of ratios in the operation of small businesses (William Beaver, 1967).  Most emphasis was on the public sector. Even recently, though there are many writes ups on the role of financial ratios, they are not as many as those written about the public sector (Verbruggen et al.., 2011). Roy A Foulke and Lorrie DuPont were among the first to detailly analyse the role of ratios in the private sector and in the Micro Finance Institutions in the 1930s. In the United Kingdom, School analysis and ratio analysis are tools to help both public and private managers improve efficiency and consider the next contract financial performance procedures (Horrigan, 2001).

The British Institute of Management has generated interest in ratio as tools for making inter firm companies to help managers appraise efficiency and to make policy decisions for the future. As the need for better financial performance increased, more articles sprang up on the part financial ratios play in the process of efficient financial performance. During the 1920s, and 1930s one can find a host of publications by Lorrie DuPont, James H. Bliss, Stephen Gilman the first writer to object ratios analysis though his write ups were given very little attention on the role of ratios in business decision and or in signalling financial distress.

In the United States, as in all other countries that now possess a developed financial ratio analysis, the only important financial instruments in existence were, until in 1840, money, short-term trade credit, long-term farm and urban mortgages, and government securities; the only important financial institutions were enterprise of issue and commercial enterprise (Lasher, 2005). In Australia, the current ratio and especially the ratio was studied for the logic and desirability and its proven use as a major component of the scientific method used in financial management. In United Kingdom, school analysis to be made universal and the ratio analysis England management as tools to compare between companies to help managers improve efficiency (Efficiency) and consider the next contract financial performance procedures (Horrigan, 2001).

In Africa commercial enterprise have undergone immense regulatory and technological changes since the attainment of constitutional democracy in 1994. South African enterprises are faced with increasing competition and rising costs as result of regulatory requirements, financial and technological innovation, entry of large foreign enterprise in the retail private environment and challenges of the recent financial crisis, so financial ratios analysis enable us to identify unique bank strengths and weaknesses, which in itself inform bank profitability, liquidity and credit quality (Robert, 2010). Profitability of Egyptian firms in 1999 was broadly in line with international experience. The profitability ratios (both operating income and net income) are the same or slightly lower than the average for other countries shown. Leverage in Egypt is lower than in most other countries in the sample. The ratio of total liabilities to total assets has a median of 0.51 for Egypt while the world median is 0.57. The lower leverage ratio in Egypt suggests that Egyptian firms may face some difficulties in raising debt finance because Egypt’s success in penetrating international markets for manufactures has been disappointing as has its low growth in total factor productivity (Inessa, 2005).

One of important assumptions process and improvement economy is existence of quality information. Significant number of this information comes from accounting information systems and from financial statements. Financial statements have to provide realistic and objective picture of realistic business condition of certain company through to the financial ratio analysis. In other words, auditing of financial statements is understandable, by which accuracy is ensured. In context of consideration of financial statements as a function of financial performance it is important to emphasize that different users must know how to “read” those statements. “Reading” contents of financial statements provide whole number of different instruments and analyses procedures for understanding business (Ehrhardt, 2010)

The process of reviewing and evaluating a company’s financial statements (such as the balance sheet or profit and loss statement), thereby gaining an understanding of the financial health of the company and enabling more. Financial statements record financial data; however, this information must be evaluated through financial statement analysis to become more useful to investors, shareholders, managers and other interested parties. Financial statement analysis is an evaluative method of determining the past, current and projected financial performance of a company which in turn enhance financial performance at organisational level (Baker & Wallage, 2000). 

One of the important assumptions process and improvement of economy is existence of quality information. Significant number of this information comes from accounting information systems and from financial statements. 

Financial statements have to provide realistic and objective picture of realistic business condition of certain company. In other words, auditing of financial statements is understandable, by which accuracy is ensured. In context of consideration of financial statements as a function of financial performance it is important to emphasize that different users must know how to “read” those statements.

 “Reading” contents of financial statements provide whole number of different instruments and analyses procedures for understanding business. A well-established process of management on the basis of the financial statements and financial information is one of the most significant presumptions of the quality business (Zager, 2000).

The use of financial reporting is the main aspect. 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 that the researcher was motivated in finding the extent to which management depends on accounting ratios in business financial performance.

As an art, management has been practiced since the early beginning of twentieth century. It had got a great evolution at the time of industrial revolution which started in England around mid-eighteenth century. Prior to this, most of business enterprises were characterized by craftsmanship rather than mechanization or technology and faced the problem much simpler than those faced by 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 economic environment that prompt entrepreneurs to react. At the same time when these changes are taking place, there were basic changes in the form of management especially in managerial strategies for financial performance; this generates separation of ownership of the business from its management. In consequences, managers had to look for the means of discharging their responsibility; this can be obtained through the use of accounting ratios.

The use of accounting ratios is a time-tested method of analysing 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 a business. Ratios are more of a diagnostic tool that helps to identify problem areas and opportunities within a company.

Decision-making can be regarded as the cognitive process resulting in the selection of a belief or a course of action among several alternative possibilities. Every decision-making process produces a final choice that may or may not prompt action. Decision making is one of the central activities of management and is a huge part of any process of implementation. Good financial performance is an essential skill to become an effective leader and for a successful career. Decision making is the study of identifying and choosing alternatives based on the values and preferences of the decision maker. Making a decision implies that there are alternative choices to be considered, and in such a case we want not only to identify as many of these alternatives as possible but to choose the one that has the highest probability of success or effectiveness and best fits with our goals, desires, lifestyle, values, and so on (Romney & Steinbart, 1997).

Presentation of financial statements is the important part of accounting process. To provide more meaningful information to enable the owners, investors, creditors or users of financial statements to evaluate the operational efficiency of the concern during the particular period. More useful information is required from the financial statements to make the purposeful decisions about the profitability and financial soundness of the concern leading to more financial financial performance, (Weygant, 2002).

Pandey (2010) argued that financial ratios (ratio analysis) are fundamental factors that determine the decision in the business operations. The most used financial ratios have been liquidity ratios, efficiency ratios and profitability ratios (Mrisho, 2014). Successive firms use financial ratio analysis to compare themselves with other firms so as to pinpoint their weaknesses and make an improvement (Kibacho, 2014). For the business institutions or organisation to be sustainable it requires effective management of the financial resources and proper plan. Financial ratios analysis is a useful tool for managing financial resources and planning for better business operations. Through financial ratios analysis of the company, one can identify weaknesses and strengths that can lead to the establishment of strategies and initiatives for the betterment of the company (Almumani and Abdelkarim, 2014). 

Financial ratios analysis is an acceptable tool for analysing a firm and its financial performance over time. Financial analysts and researchers combine key financial ratios (quantitative measures) over time and across industries alongside with qualitative measures to gain insight regarding the firms (Barnes, 1987 and Nkoba, 2010). Hoskin (2017) mentioned that ratios are used to represent outcomes of decisions made by the firm and the results of outside conditions surrounding the firm. Therefore, financial ratios seem to be a very important tool in investment financial performance for the firms. The effective financial performance of an organisation depends much on the number of human resources who can deploy the available assets to generate income (Abdulrahman, 2011). Proper decisions on human resources investment can be reached when there is an effective analysis of financial ratio compared concurrently with human resource ratio like productivity ratio (Alshati, 2015).

Likewise, opening a different branch has meaning on private enterprise and it is considered an extension of its normal business to gain more revenues and thus increase its profitability which will enhance the liquidity of the company (Burja 2011). Despite that fact, the opening of a new branch of a bank needs proper evaluation of a number of factors such as economic factor, social factor and political factor, but the financial factors are also very important in analysis mechanism (Caddy, 2000).

With reference from Mercy (2014), financial institutions use financial ratios as a guiding factor for making decision in their operations to make investment decisions. Financial ratios help the private enterprise  to determine the loan provision rate as well as how far private enterprises can open new branches as well as how they can employ new employees to meet an increased their operation (Erasmus,2015).Unfortunately, there are limited studies that had been empirically examined whether financial ratios analysis form the basis of investment decisions in Cameroonian private sector. Therefore, it is upon this background, the researcher is amplified to find out the influence of financial ratio analysis on investment financial performance, in private Micro Finance Institutions.

• 2. Statement of the Problem

A firm’s capacity to remain profitable is believed to be strongly connected to characteristic such as liquidity, financial leverage, and efficiency. Notable, however, is the fact that despite the key company features described here being factors that can predict performance, previous empirical investigations have been unable to establish this as fact. Dang (2011) holds that liquidity ratios, capital adequacy ratios, credit risk ratios and management quality ratios are predictors of financial performance. This view has however been challenged by some past studies which have found that some financial ratios cannot be used in predicting financial performance (Ismail, 2013; Almajali, Alamro & Al-Soub, 2012).

Empirical research on ratio analysis predicting financial performance is present but there exist conceptual, contextual and methodological research gaps. Shukla and Bajpai (2015) studied how management of credit risk and bank profitability relate and noted that the two variables were directly correlated. There exists a contextual gap as this study was conducted in Rwanda. Further, there exists a conceptual gap as this study did not consider other ratios. Rifqah and Hafinaz (2019) analyzed how credit risk, liquidity, and capital adequacy of banks in Indonesia impact profitability. Findings from the study showed presence of a substantial negative relation between the dependent variable (ROA) and the independent variables (NPLR, LDR, and CAR). This research presents a contextual gap as it focused on microfinance institutions. Orang’i (2018) examined how management of credit risk impacted the performance of Kenyan banks using a descriptive research design. The examination showed that risk identification is insignificant to performance while risk monitoring is positive and significant to performance.

Financial ratio analysis is important to the management, owners, personnel, customers, suppliers, competitors, regulatory agencies, tax payers and lenders each having their views in applying financial statement analysis in their evaluations and making judgments about the financial health of organisation. Many financial organisations also compare their own ratio values to those for similar organisations looking for differences that could indicate weaknesses or opportunities for improvement (Vincent, 2013).

According to Khalad (2011) financial ratios analysis focus on financial results that reflect the owners’ perspective, whereas the Balanced Scorecard focuses on financial and nonfinancial results that reflect not only the owners’ perspective, but also the customer perspective, internal process perspective and learning and growth perspective. So, they found that financial ratios analysis is not an adequate method by which to evaluate the overall financial performance of an organisation; also, the balanced scorecard is more efficient than financial ratios analysis. The above statements shows that some studies found that financial ratios analysis is good tool while others said that there are other useful tool rather than financial performance, therefore, this study needs to analyse whether analysis of profitability ratio, efficiency ratio, liquidity ratio and asset quality ratio affects the financial performance of  Micro Finance Institutions in Bamenda.

• 3. Research Questions
• 3.1. Main Research Question

What are the effects of accounting ratios on the financial performance of Micro Finance Institutions in Bamenda?

• 3.2. Specific Research Questions

1. To what extent does liquidity ratio analysis contribution to the financial performance of Micro finance Institutions in Bamenda?
2. What are the effects of efficiency ratios analysis on the financial performance of Micro finance Institutions in Bamenda?

• To what extent is asset quality ratios analysis on the financial performance of Micro finance Institutions in Bamenda?

1. What is the role of profitability ratios on the financial performance of Micro finance Institutions in Bamenda?

• 4. Objectives of the Study

This study presents the main objective and four specific objectives of the study related to the problem and topic under study.

• 4.1. Main Objective

The main objective of this study is to examine the effects of accounting ratios on the financial performance of Micro Finance Institutions in Bamenda.

• 4.2. Specific Objectives

1. To assess the extent to which liquidity ratio analysis contributes to the financial performance of Micro Finance Institutions in Bamenda.
2. To examine the extent to which efficiency ratio analysis affects the financial performance of Micro Finance Institutions in Bamenda.

• To evaluate the extent to which asset quality ratio analysis affects the financial performance of Micro Finance Institutions in Bamenda.

1. To assess the role of profitability ratio analysis on the financial performance of Micro Finance Institutions in Bamenda.