The study highlights further use of accounting ratios by considering it as the main factor for value detecting, value enhancing and value sustainability tool. This is carried out by investigating the effect of accounting ratios on the performance of the listed firms in Nigeria.
The study examining the relationship between accounting ratios and firm value sustainability. It further studied the effect of accounting ratios on firm’s value sustainability.
The study provoked an insight that accounting ratios should not only be used to analyse and interpret company’s financial health but also be used as a tool that guides companies’ operation for value sustainability.
The study employed data retrieved from sampled listed firm’s annual reports and centered the study on agency and signaling theories. The data were evaluated using descriptive analysis, Pool ordinary least square (OLS), random effect and panel generalised method of moment (GMM). Thirty firms representing all sectors except the financial sector from 2008 to 2017 were sampled using a stratified sampling method. The dependent variable is Tobin’s q, whilst the explanatory variables are also proxy by accounting ratios.
The study revealed that accounting ratios do not only affect and influence firm value but also help to detect if value had been created or not, as well as if the value created has been sustained over years. It further revealed a significant and positive relationship between ratios used in the study (current ratio, ROA, asset turnover, debt-equity ratio and earnings per share) and firm’s value.
The study therefore recommended that a comprehensive accounting ratio that comprises both conventional accounting ratios and sustainability accounting ratios should be published. This should be published alongside with the firm’s financial statement for ease of interpretation and determination of the yearly performance by any stakeholder who may want to interpret the report for an informed decision.
It then stated that a before tax sustainability rate law should be enacted for easy determination of sustainability ratio. The study contributed to decision makers, Accounting Profession, Corporate Organizations and Government.
Value sustainability is one of the problems that affect firms. So many firms liquidate today as a result of failure to sustain their value, which may be because of so many reasons such as lack of good governance, liquidity problem, stunted growth rate, etc. The accounting profession relies on sustainability because of conventional and fundamental ‘going concern’ concept. The ‘going concern’ presumed that a firm is expected to operate for the foreseeable future. Sustainability reporting has become important as stakeholders seek for more information about their investments. Sustainability report is broader than it was before as it considers other factors that can affect firm’s survival within the firm and the environment in which the firm operates. Hence, there is a need for a sustainable growth rate that will not only help to survive but also to freely compete with any type of competitor in whatever industry such firm operates. Any firm that fails to grow may equally fail to sustain its value over years. The connection between accounting ratios and value sustainability is the yearly growth in firm’s accounting ratios, which is a good measure of performance and a signal that value of such firm is sustained. However, Fonseka, Ramos and Tian (
Accounting ratios are the language of the business and the only tool that connects the chairman, CEO, board of directors, other management teams and other stakeholders together as argued by Enekwue (
Realistically, assessment of firm’s sustainability at country based, Nigeria listed firms complied with the IAS 1 directive as directors are mandated to report ongoing concern and sustainability of their firms in the note to the financial statement. However, the overall economic performance and other sustainability social performance of the listed firms ultimately depend on how reliable the information in the annual report is (Tsegba, Semberfan & Tyokoso
The failure and collapse of firms around the world have increased the interest of researchers in determining the reasons why some promising corporations are failing despite their robust annual financial reports. Accounting ratios help to glean information from annual published financial statements and to detect whether value had been created through a firm’s operation or not. This calls for the management and directors of firms to be more careful in their operations and to be more transparent and accountable for all their business activities. It also calls for them to be more active in establishing more models relating to accounting ratios in terms of governance that enhance firms’ value in order to put an end to failure of corporate organisations around the world. One of the concepts that lead to good accounting ratios is to have good internal control and good governance in place. In fact, poor accounting ratios are a product of bad governance, thus managers introduce cosmetic accounting by window dressing financial records in order to impress the shareholders of firms and other interested stakeholders (Enekwue
Studies around this topic mostly based their research on multitheoretical framework such as studies of the following scholars: Loh, Thomas and Wang (
Extant studies were reviewed to discover existing gaps in the literature in relation to this study and it was discovered that there are few studies on accounting ratios and value sustainability in the world literature and in the Nigerian context. Martani and Khairurizka (
Fonseka et al. (
Summary of the review revealed that the majority of the researchers on accounting ratios and value sustainability agree that accounting ratios have strong influence on value sustainability. The connection between accounting ratios and value sustainability is the yearly growth in firm’s accounting ratios, which is a good measure of performance and a signal that value of such firm is sustained. Zabolotnyy and Wasilewski (
An accounting ratio is an arithmetical expression, that is, relationship of one number to another in the form of a percentage. The accounting ratio is a nexus, link and signal between management and shareholders and all other users of financial statement (Enekwue
It has been discovered nowadays that shareholders and other stakeholders especially investors are not only demanding accountability and transparency but also sustainability of the value created by their firm. Today, as part of firms’ annual report in the note to the account, directors are mandated to make sustainability report of their firm as an answer to stakeholders’ request (IAS 1). Value sustainability becomes important for all firms to remain alive. It is one thing for firm to create value but it is another thing for that firm to sustain that value created. This study sees accounting ratios as the nexus between value created by a firm and value sustained by that firm. Value sustainability can be divided into two parts: internal and external. This is further subdivided into financial and non-financial value. Financial type is related to internal value whilst non-financial type is also related to external value. External value of a firm can be likened to the firm’s value of goodwill and other fictitious or non-visible assets and the firm’s corporate social responsibility. Whichever way one views a firm’s value, it can be quantified by accounting ratios. The big question is what relationship accounting ratios have with value sustainability? Accounting ratios improve communication with stakeholders (Enekwue
The relationship between accounting ratios and value sustainability.
In spite of all the disadvantages that surround accounting ratios, it is still the fast, best, quantitative and comprehensive way of analysing firm performance. However, this study discovered that the best way of sustaining firm’s value is by employing accounting ratios and economic value added with the use of information in the financial statements. Those accounting ratios are ROCE, Return on Net Asset (RONA) and they can be used to detect the value created by the firm over time. This is carried out by comparing the value computed by those ratios with the firm’s WACC over the years. It is referred to as the economic value added approach and it is simply a division of profit after tax by the net operating assets
There are two types of users of financial information: internal users and external users, and there is always information asymmetry between them. External users obtain information through the published financial statements of the firm, especially through reported ratios attached to the report. However, ratios that detect whether firms retain their values are very important for continuity and for decision-making. This is the main reason why financial statement should possess a fair representation of the firm’s affair and provide assurance that financial statements are a true representation of the firm’s financial activities, as debated by Ingram and Albright (
Interaction between accounting ratios and firm’s value.
This study only considered secondary data, which was retrieved from the firm’s annual reports. The study adopted E-views 9.0 to analyse the data based on a stratified and convenience sampling method. For the purpose of this study, each sector was considered as a stratum and all sectors were considered except the financial sector because of the peculiarity of their financial statements. Firms that had their up-to-date data online were given priority, with at least one firm representing each sector. The dependent variable of the study is firm’s value, which is represented by Tobin’s q, and accounting ratios are independent variables. Each ratio was computed from the information in the annual reports and at least one ratio represents each classification. In this study firms with 10 years up-to-date financial statement at the Nigeria Stock Exchange Fact Sheet were being selected for this purpose. The justification for selecting this period was that it reflects the corporate governance practices of firms after these listed companies in the Nigeria Stock Exchange (NSE) were obliged to apply the rules of corporate governance in 2003 in Nigeria.
This section presents the empirical model that expresses the linear association between accounting ratio variables and the firm’s value of the sampled firms. The dependent variable is firm’s value and that of accounting ratios variables are:
ROA, asset turnover (ASST), EPS, quick ratio (QR), debt-equity ratio (DER). The linear model is stated below, following the work of Karaca and Savsar (
Accounting ratios are further incorporated into the given model to arrive at the following model:
where FV and Qit represent firm’s value (dependent variable) and α0 is the intercept coefficient of the level of performance of the firm and β1, β2…. are the parameters used in the model that represent the slope of each variable, whilst X1it, X2it, X3it…. ROAit, ASSTit……… are the explanatory variables used to proxy accounting ratios and εit represents the error term. The ‘it’ in the model suggested that the work employed time series and cross-sectional data for the study.
To examine the relationship between accounting ratios and firm’s value sustainability, we start with the analysis of the descriptive statistics of all the variables. This provides information about the measures of central tendencies such as mean, median and the minimum and maximum values. The mean value measures the average value of all the variables used, whilst the median measures the middle value. In addition, the descriptive statistics also provide information about the measures of dispersion such as standard deviations, skewness, kurtosis and Jarque–Bera and the probability of Jarque–Bera. Standard deviation explains the deviation of the value of each of the variables from the mean. Whilst skewness measures the shape of the distribution, kurtosis measures the peakedness of the distribution. Jarque–Bera test and its probability are used to confirm the validity or otherwise of the normal distribution. The descriptive statistics result is presented in
Descriptive statistics.
Variables | Tobin-Q | Current ratio | ROA | Asset turn over ratio | Debt-equity ratio | Earnings per share |
---|---|---|---|---|---|---|
Mean | 1.154466 | 1.724198 | 5.850229 | 1.176374 | 1.176374 | 4.686718 |
Median | 0.850000 | 1.100000 | 4.615000 | 1.285000 | 1.285000 | 1.955000 |
Maximum | 19.39000 | 120.0000 | 29.00000 | 36.82000 | 36.82000 | 87.16000 |
Minimum | 0.050000 | 0.000000 | −43.20000 | −343.1700 | −343.1700 | −240.0000 |
s.d. | 1.630970 | 7.374022 | 8.886839 | 21.88386 | 21.88386 | 20.65425 |
Skewness | 8.352585 | 15.84018 | −0.735075 | −14.89988 | −14.89988 | −6.109851 |
Kurtosis | 86.06692 | 254.5585 | 8.198788 | 235.8536 | 235.8536 | 79.81531 |
Jarque–Bera test | 78372.67 | 701781.5 | 318.6437 | 11637.99 | 601604.7 | 66044.89 |
Probability | 0.000000 | 0.000000 | 0.000000 | 0.000000 | 0.000000 | 0.000000 |
Sum | 302.4700 | 451.7400 | 1532.760 | 672.6900 | 308.2100 | 1227.920 |
Sum Sq. Dev. | 694.2765 | 14192.19 | 20612.71 | 6593.251 | 124993.8 | 111342.1 |
Observations | 262 | 262 | 262 | 262 | 262 | 262 |
ROA, return on asset; s.d., standard deviation; Sum, summation ; Sum Sq. Dev., sum of square deviation.
The next step examined the degree of association amongst the variables because a high level of correlation between two independent variables will result in a multicollinearity. To verify this claim, the study adopted a correlation matrix and results are presented in
Correlation matrix.
Variables | TQ | Current ratio | ROA | Asset turn over | DER | EPS |
---|---|---|---|---|---|---|
TQ | 1.000000 | - | - | - | - | - |
CR | −0.020420 | 1.000000 | - | - | - | - |
0.74 | - | - | - | - | - | |
ROA | 0.153575 | 0.047773 | 1.000000 | - | - | - |
0.01 |
0.44 | - | - | - | - | |
ASST | 0.011518 | −0.026165 | −0.128868 | 1.000000 | - | - |
0.85 | 0.67 | 0.03 |
- | - | - | |
DER | −0.005709 | 0.002489 | 0.213617 | −0.169840 | 1.000000 | - |
0.92 | 0.96 | 0.00 |
0.00 |
- | - | |
EPS | 0.158922 | 0.004759 | 0.326222 | 0.064775 | 0.033493 | 1.000000 |
0.01 |
0.93 | 0.00 |
0.29 | 0.58 | - |
Note: * & ** represent a level of significance at 1% and 5%, respectively.
TQ, Tobin’s Q; CR, current ratio; ROA, return on asset; ASST, asset turnover; DER, debt-equity ratio; EPS, earnings per share.
Furthermore, one of the major problems of time series data is non-stationarity. For reliability of the result, a panel unit root test was conducted on the variables using three approaches (Im, Pesaran & Chin
Panel unit root test.
Variables | Im et al. ( |
Levin Lin Chu |
Fisher PP |
||||||
---|---|---|---|---|---|---|---|---|---|
Level | F.D | Remarks | Level | First. Diff | Rmk | Level | First dif | Rmk | |
Tobi Q | −10.7353 |
- | I(0) | −94.7535 |
- | I(0) | - | - | - |
CR | −2.51170 |
- | I(0) | −8.30052 |
- | I(0) | - | - | - |
ROA | −3.43876 |
- | I(0) | −27.5227 |
- | I(0) | - | - | - |
ASST | −5.16608 |
- | I(0) | −16.0754 |
- | I(0) | - | - | - |
DER | −1.41824 |
- | I(0) | −3.43571 |
- | I(0) | - | - | - |
EPS | - | - | - | −0.48619 | −8.11936 |
I(1) | 0.087 | −2.027 |
I(1) |
Note: *, ** & *** represent a level of significance at 1%, 5% and 10%, respectively.
Var, variables (CR, ROA, ASST, DER, and EPS); F.D, first difference of all the variables; Rmk, remarks; Tobi Q, Tobin’s Q; CR, current ratios; ROA, return on asset; ASST, asset turnover; DER, debt-equity ratio; EPS, earnings per share.
Having examined the stationarity level of all the variables, the next step is to confirm the existence of long-run relationships amongst them, which is the co-integration test. There are two approaches available for this test. The first is the Pedroni co-integration test, whilst the second one is the Kao residual co-integration test. Whilst Pedroni can handle seven variables at once, Kao residual can handle more than seven variables. As the variables are six together with the dependent variable, the study then employed the Pedroni co-integration test. The result is presented in
Co-integration test.
Variables | Statistic | Probability | Weighted |
|
---|---|---|---|---|
Statistic | Prob. | |||
Panel v-statistic | −3.922872 | 1.0000 | −3.272113 | 0.9995 |
Panel rho-statistic | 5.775807 | 1.0000 | 4.815575 | 1.0000 |
Panel PP-statistic | 1.284185 | 0.9005 | −5.333594 | 0.0000 |
Panel ADF-statistic | 5.110916 | 1.0000 | 1.476546 | 0.9301 |
Group rho-statistic | 6.974951 | 1.0000 | - | - |
Group PP-statistic | −9.853178 | 0.0000 | - | - |
Group ADF-statistic | 0.924141 | 0.8223 | - | - |
Approval to conduct the study was received from the Economic and Management Sciences Research Ethics Committee North-West University (NWU-01374-19-A4).
To achieve the objective using the model specified in
Dependent variable: Tobin
Variables | Pool OLS | Random effect | GMM |
---|---|---|---|
Constant | 0.978 (0.00)* | - | - |
Tobin-q(-1) | - | - | 0.49 (0.00)* |
Current ratio | −0.005 (0.66) | −0.0007 (0.95) | 0.07 (0.00)* |
Return on assets | 0.022 (0.06)*** | 0.020 (0.12) | 0.002 (0.00)* |
Asset turn over | 0.004 (0.83) | 0.0005 (0.98) | 0.015 (0.00)* |
Debt-equity ratio | −0.002 (0.59) | −0.001 (0.65) | 0.003 (0.018)** |
Earnings per share | 0.009 (0.07)*** | 0.003 (0.49) | 0.003 (0.00)* |
0.03 | 0.01 | - | |
Adj. |
0.02 | −0.004 | - |
2.07 (0.06) | 0.74 (0.58) | - | |
Hausman’s specification test | - | 8.09 (0.15) | - |
- | - | 21.19 | |
Instrument rank | - | - | 27 |
Cross-sections included | 27 | 27 | 27 |
Total observation | 262 | 262 | 208 |
OLS, ordinary least square; GMM, generalised method of moment; Adj., adjusted.
Results of the random effect is similar to that of pool OLS. For the random effect, current ratio and debt-equity ratios are inversely related to firm values but not statistically significant whilst other variables are positive with statistically significant impacts. From the results as well, it can be deduced that both current ratio and debt-equity ratio as a proxy for accounting ratio are inversely related to firm value whilst debt-equity ratio has a positive influence on firm value. Mathematically, for pool OLS, a 1% increase in the current ratio and debt-equity ratio will increase firm’s value by 0.66% and 0.59%, respectively. For the random effect as well, a 1% increase in current asset and debt-equity ratio increases firm value by 0.95% and 0.65%, respectively.
We further employed system-GMM as proposed by Arellano and Bover (
From the given results, the findings of this study are as follows: that accounting ratios are a good factor within the context of value creation, value enhancing tool and value sustainability tool. This was established from the given results that revealed a positive and significant effect on firm’s value. How accounting ratios can detect the value of a firm as revealed and conceptualised by the definition of ROCE in different forms, RONA and ROA can help to discover whether the value has been created. These ratios are very important in relation to value sustainability. Sustainability growth rate, firm’s performance and value can be determined from firm’s yearly performance by accounting ratios. As accounting ratios can measure sustainability rate, value sustainability and accounting ratios are closely related. The need for this is that shareholders and other investors are not only asking for accountability and transparency, but also sustainability of the value created by the firms annually. From the given analysis result, it was revealed that the two investors’ ratios employed as part of the accounting ratios (ROA and EPS) are positive and significant at 10% and at 1% under pool OLS and GMM, respectively. It was also revealed that the value of the ROA was greater than WACC, considering the year under review. It was also found that the results support existing studies, which support that accounting ratios affect firm value positively. The results from the analysis revealed little positive effect on firm value. The real reason why some promising firms are folding up in Nigeria can therefore be attributed to a lack of close monitoring of a firm’s ratios, as this would reveal the area of strength, weakness and even to know whether the value created is sustained. Therefore, this study contributes to knowledge by adding to the existing literature to fill the gap created in the Nigerian framework. Prior to this study, there had not been any work on accounting ratio and firm value in the Nigerian context and even if there is, it could either be very few or might even not cover all sectors like this study did. This study therefore further adds to the body of knowledge that accounting ratios affect firm value by helping management to detect whether the value had been created or not and whether the value created is sustained or not by providing a direction of what decision to take. Therefore, this study also clears the argument of whether or not accounting ratios affect firm value from the results of the analysis and there is close relationship between accounting ratios and value sustainability. The study hereby suggests that the management of organisations should always compute comprehensive ratios in order to detect areas that need urgent attention to guide against corporate failure.
In conclusion, this study looked into accounting ratios and the firm value sustainability by assessing the effect of ratios on firm value and examined if there is relationship between accounting ratios and value sustainability. Panel data analysis was constructed and the study employed system-GMM for the analysis. The hypothesis of the study H1, which says ‘accounting ratios have an effect on the firm value’, is accepted by the results from the analysis. All accounting ratio variables used in this study have positively and statistically related to firm value. According to the result, although the effect of all the variables is small but they all have a positive impact. For instance, a 1% increase in current ratio, ROA, asset turnover, DER and EPS increases the value of the firm by 0.07%, 0.002%, 0.015%, 0.003% and 0.003%, respectively. However, small it may be, it is still a positive influence that means a lot to any firm. In general, considering all accounting ratios used in this study, the study revealed that accounting ratios have a positive and significant influence on the value of any firm. This infers that accounting ratios enhance and improve the value of the firms listed in Nigeria. In addition, value sustainability determination involves both financial and non-financial measure of firm performance. Managers can only determine how value is created and sustained through the calculation of certain accounting ratios from annual report. Some accounting ratios revealed the firm’s rate of performance and these ratios can be employed to determine whether firms retain or loss value. Therefore, a close relationship between accounting ratios and value sustainability is confirmed. Zabolotnyy and Wasilewski (
The authors have declared that there is no competing interest.
All authors contribute equally to this work.
This research received no grant from any funding agency in the public, commercial and not-for-profit organisation.
Data used for this article were retrieved from companies’ financial statements listed on the Nigerian Stock Exchange. There was no new data created.
The views and opinions expressed in this article are those of the authors and do not necessarily reflect the official policy or position of any affiliated agency of the authors.