1.0 Introduction
1.1 Background of Study
Today, the use of financial statements is central to performance assessment in organizations. They provide a comprehensive view of profitability, liquidity, and solvency, forming the basis for investment decisions, credit evaluations, and management assessments. However, the historical limitations of financial statements, such as their focus on historical data and susceptibility to manipulation, continue to drive the development of more integrated approaches to performance evaluation, combining financial and non-financial measures.
The use of financial statements as a tool for assessing the performance of organizations has long been an essential practice in the field of finance and accounting. Financial statements provide a formal record of an entity's financial activities and position, and they are widely regarded as the cornerstone of financial reporting. These reports not only serve regulatory and compliance purposes but also provide critical information for decision-making by various stakeholders, including investors, management, creditors, and regulators (Wild, 2018).
Financial statements are documents that provide a formal record of the financial activities and position of an organization. They typically include the income statement, balance sheet, and cash flow statement. These statements are used to assess the profitability, liquidity, and solvency of an organization (Penman, 2013). Financial statements are indispensable tools in the assessment of an organization's performance. They provide a structured representation of the financial activities and conditions of a business entity, offering key insights into its profitability, liquidity, and solvency. By examining financial statements, stakeholders such as investors, creditors, and management can make informed decisions regarding the company's financial health. According to Brigham and Ehrhardt (2017), financial statements not only reveal the historical financial performance of an organization but also help in predicting future trends and assessing the firm's value.
Historically, the development of financial reporting has been closely tied to the growth of corporate structures and the need for accountability in business. According to Nobes and Parker (2016), as businesses expanded in size and complexity, the need for standardized financial reporting grew, leading to the establishment of frameworks like Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). These frameworks ensure that financial statements are prepared in a consistent and transparent manner, facilitating comparative analysis and decision-making across different entities and time periods. Therefore, in Nigeria where the research was carried out, the activities that was conducted is to know the use of financial statements in assessing the performance of an organization.
1.2 Statement of Problems
Investigation revealed that financial statements often fail to capture non-financial factors that are increasingly recognized as critical to organizational success. Aspects like employee morale, customer satisfaction, and innovation are not reflected in traditional financial reports, yet they play a crucial role in a company’s long-term performance (Ittner & Larcker, 2003).
Furthermore, financial statements are prepared under various accounting standards such as GAAP or IFRS, which sometimes lead to inconsistencies in reporting practices across organizations and regions. These inconsistencies make it difficult for stakeholders to compare performance across different firms, particularly in a globalized economy (Nobes & Parker, 2016). It is against the backdrop that this study seeks to address these problems by evaluating the use of financial statements in assessing the performance of an organization.
1.3 Aim and Objectives of Study
The aim of the study is to critically analyze the use of financial statements in assessing the performance of an organization. In achieving this aim, the following specific objectives were laid out as follows:
- To examine the role of financial statements in providing insights into an organization’s profitability, liquidity, and solvency.
- To identify the limitations of using financial statements as the primary method for performance assessment.
- To analyze the potential for manipulation of financial data and its impact on performance evaluation.
- To explore how financial statements can be supplemented with non-financial performance indicators for a more comprehensive assessment.
- To provide recommendations for improving the effectiveness of financial statements in organizational performance assessment.
1.4 Research Questions
The study came up with research questions so as to be able to ascertain the above stated objectives. The specific research questions for the study are stated below as follows:
- How effective are financial statements in assessing an organization’s profitability, liquidity, and solvency?
- What are the limitations of using financial statements as the sole tool for evaluating organizational performance?
- To what extent can financial data be manipulated, and how does this affect performance assessment?
- How can non-financial performance indicators be integrated with financial statements to provide a more comprehensive view of an organization’s performance?
- What strategies can be employed to improve the accuracy and reliability of financial statements in assessing organizational performance?
1.5 Research Hypothesis
In order to pursue the objective of this study, the following generalized statements have been designed to guide and aids in obtaining the result for the experiment to be conducted. For this work, the null hypothesis will be represented with H0 while the alternative hypothesis will be represented with hypothesis H1.
- H0: Financial statements alone are not sufficient and reliable for assessing the overall performance of an organization.
- H1: Financial statements alone are sufficient and reliable for assessing the overall performance of an organization.
1.6 Significance of Study
The study will offer investors a deeper understanding of the limitations of financial statements, helping them make more informed decisions by considering both financial and non-financial performance indicators.
For creditors, the study will provide insights into how financial statements may mask potential risks, aiding in the assessment of an organization's true financial health and creditworthiness.
Management will benefit from the study by gaining a comprehensive view of how financial statements can be complemented with other performance metrics to improve internal performance evaluations and strategic planning.
Regulators will find the study significant as it will highlight areas where current financial reporting standards may fall short, potentially guiding future revisions to enhance the reliability and transparency of financial statements.
Finally, academic researchers will gain valuable perspectives from the study, contributing to the body of knowledge on financial reporting and performance assessment, and supporting further research in this field.
1.7 Scope of Study
The scope of the research is focused on the Critical Analysis on the Use of Financial Statements in Assessing the Performance of an Organization using First Bank PLC Nigeria as a case study.
1.8 Limitations of the Study
The study was limited by insufficient data, which impacted the depth and comprehensiveness of the analysis. Without access to complete and detailed financial information, it was challenging to draw definitive conclusions about the effectiveness of financial statements in assessing organizational performance.
Delays from respondents also posed a challenge, affecting the timeliness of data collection and potentially impacting the relevance and accuracy of the findings. The slow response rate from some participants limited the scope of input and feedback necessary for a thorough evaluation.
Financial constraints were a further limitation, restricting the resources available for extensive data collection and analysis. Budget limitations affected the study’s ability to access premium databases or hire additional research support.
Time constraints were another factor, as the study had to be conducted within a fixed timeframe. This restriction limited the depth of analysis and the ability to explore all aspects of financial performance assessment thoroughly.
1.9 Definition of Terms
Financial Statements: Documents that provide a formal record of the financial activities and position of an organization. They typically include the income statement, balance sheet, and cash flow statement. These statements are used to assess the profitability, liquidity, and solvency of an organization (Penman, 2013).
Income Statement: Also known as the profit and loss statement, this financial document shows the organization's revenues, expenses, and profits over a specific period. It helps in evaluating the company’s operational performance and profitability (Wild, 2018).
Balance Sheet: A financial statement that provides a snapshot of an organization's assets, liabilities, and shareholders’ equity at a specific point in time. It is used to assess the organization’s financial position and stability (Nobes & Parker, 2016).
Cash Flow Statement: A financial report that outlines the cash inflows and outflows from operating, investing, and financing activities over a period. It helps in assessing the organization's liquidity and its ability to generate cash (Penman, 2013).
