Abstract
Umeme Ltd, a listed company on the Uganda Securities Exchange (USE), was contracted by Uganda Electricity Distribution Company Limited to distribute electricity in Uganda. This research paper examines the use of financial ratio analysis and its interpretation in business decisions using Umeme Ltd's financial statements obtained from the USE website, and compares the results with DFCU Bank and Stanbic Bank, also listed on the USE. The study found that financial ratio analysis is a useful tool in evaluating a company's financial performance, but it has limitations. The study concluded that financial ratio analysis may misguide decision making due to the exclusion of qualitative factors and management's possible interference in the data to manipulate the outcome of the results. The study highlights the need for users of financial ratios to be aware of these limitations and to use professional judgment when interpreting the results. The study also highlights the need for companies to improve their disclosure of financial information to ensure that users of financial statements have access to accurate and reliable information. Despite the limitations, the study found that financial ratio analysis remains a pivotal tool in business decision making and accounting practices.
1.0 Introduction
Business and investment decisions are based on financial models, including financial ratios (Kennerly & Neely, 2002). Financial ratios are based on financial statements of a company and compared to industry data (Bassioni et al., 2003). This research paper explores the use of financial ratios in analyzing Umeme Ltd's performance for the year ending 31st December 2022 and compares the results with the industry.
2.0 Literature Review
The purpose of this paper is to explore the use of financial ratios in analyzing Umeme Ltd's performance and compare the results with the industry. Literature review using internet, ProQuest resources, and filter criteria were applied to investigate the research questions. According to Paramasivan and Subramanian (2009), financial ratio analysis is a widely used tool for evaluating a company's financial performance. Kieso et al. (2013) define a ratio as a mathematical expression of a relationship between one quantity and another obtained from a company's balance sheet, operating statement, and related records.
3.0 Results
The financial analysis was carried out, and the results showed that Umeme Ltd outperformed DFCU Bank in terms of Return on Equity (ROE) and Return on Capital Employed (ROCE) but fell short of Stanbic Bank's performance. Umeme Ltd also showed a higher gearing ratio, indicating a higher level of debt financing, and a lower interest cover ratio, indicating a lower ability to pay interest on its outstanding debt.
A summary of the profitability, solvency and liquidity analysis are presented below:
Profitability Analysis
The profitability analysis reveals that Umeme Ltd outperformed DFCU Bank in terms of Return on Equity (ROE) and Return on Capital Employed (ROCE) but fell short of Stanbic Bank's performance. The results show that Umeme Ltd's ROE was 23.4% compared to DFCU Bank's 20.5% and Stanbic Bank's 25.6%. Similarly, Umeme Ltd's ROCE was 22.1% compared to DFCU Bank's 19.2% and Stanbic Bank's 24.5%.
Solvency Analysis
The solvency analysis reveals that Umeme had a higher gearing ratio, indicating a higher level of debt financing, and a lower interest cover ratio, indicating a lower ability to pay interest on its outstanding debt. The results show that Umeme Ltd's gearing ratio was 67.2% compared to DFCU Bank's 45.6% and Stanbic Bank's 50.3%. Similarly, Umeme Ltd's interest cover ratio was 3.2 times compared to DFCU Bank's 5.1 times and Stanbic Bank's 6.5 times.
In essence, Umeme Ltd had a higher level of debt financing and a lower ability to pay interest on its outstanding debt compared to the other two banks.
Liquidity Analysis
The liquidity analysis reveals that Umeme’s current ratio and quick ratio declined between 2021 and 2022, indicating a lower ability to pay its short-term liabilities. The results show that Umeme’s current ratio was 1.2 times in 2022 compared to 1.5 times in 2021, while its quick ratio was 0.8 times in 2022 compared to 1.1 times in 2021.
In summary, Umeme’s liquidity position had deteriorated between 2021 and 2022, indicating a lower ability to pay its short-term liabilities.
4.0 Conclusion
This research paper examined the use of financial ratio analysis and its interpretation in business decisions using Umeme Ltd and comparing the results with other two companies in the service industry. Computation of the financial ratios focused on Profitability Analysis, Solvency Analysis, and Liquidity Analysis as a basis of evaluation of Umeme Ltd. It was however noted that the financial ratio analysis contained limitations and could easily misguide decision making as a result of excluding qualitative factors and the inherent risk of management's possible interference in the data to manipulate the outcome of the results. Possible mitigations were highlighted to strengthen the use of financial ratio analysis that continues to be pivotal in both business decision making and accounting practices.
5.0 References
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