Financial Statement Analysis of the Banking Sector

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ICBI 2010 - University of Kelaniya, Sri Lanka

THE VALUE RELEVANCE OF FINANCIAL STATEMENTS’ INFORMATION: WITH SPECIAL REFERENCE TO THE LISTED COMPANIES IN COLOMBO STOCK EXCHANGE. W.V.A.D. Karunarathne Doctoral Candidate, Department of Government Economics, Huazhong Normal University, Wuhan, Hubei, P.R. China. anurawvadk@kln.ac.lk / anurawvadk@gmail.com R.M.D.A.P. Rajapakse Faculty of Commerce and Management Studies, University of Kelaniya, Sri Lanka. amilarajapakse@gmail.com .

ABSTRACT
Investors and other interest parties of accounting make use of financial statements and disclosures, among other publically available information, to assess the risk and value of firm when taking the investment decisions. According to Sushma Vishnani, Bhupesh Kr. Shah (2008) “Value relevance” implies ability of the financial information contained in the financial statements to explain the stock market measures. The purpose of this paper is to investigate the value relevance of financial information that extracted from financial statement directly or indirectly. Especially the study considered the value relevance of earnings and cash flows in stock prices. In addition, the study pays attention on the firm size effect on value relevance. A hundred (100) companies have been selected to the sample representing the all the business sectors except banking, finance and insurance over a period of 5 years from 2004 to 2008 listed in the Colombo Stock Exchange (CSE) and the pooled time regression method is used to analyze the data. Return model as well as Price model was used to determine the value relevance of financial statements’ information. It revealed that the value relevance of accounting information under the Price model has more explanatory power than Return Model. The empirical results of the study indicate that Earning Per Share (EPS) is the most value relevant variable in this study and it is significant at 0.01 level. Regression of earnings, book value and cash flows on stock price results indicate that the cash flows from investment is another value relevance variables at 0.01 significant level. When running stepwise regression to determine the best model of value relevance, EPS is the only value relevant variable for determining stock prices.

Key Words: Earnings, Cash Flows, Value Relevance, Stock Return, Colombo Stock Exchange.

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ICBI 2010 - University of Kelaniya, Sri Lanka

INTRODUCTION In recent times, the value relevance of financial information has been increasingly concerned by the researchers. Value relevance is one of the basic attribute of quality of the financial statements (Francis et al. 2004). High quality accounting information is a pre-requisite for well functioning capital markets and economy as a whole and as such should be of importance to investors, companies and accounting standard setters (Hellstron 2005). Particularly in order to be relevant accounting information must among others for quick response to user’s needs. Investors are not in a position to directly access the performance of the company in which they are intended to invest. They usually depend on the financial statements prepared by the management of the company. Rational investors use those financial reports and disclosures, among other publically available information to assess the risk and the value of the firm. Value relevance is defined in the exact as association between accounting amount and security market values. Researches on value relevance of accounting information, its historical development and its comparison among different countries have been increased since the 1990s. More recently studies addressed on the contribution of cash flows, earnings and book value when assessing the value relevance of the firm. This paper studies about the association between stock returns and accounting related information such as Earnings, Cash flows, book value of equity, Firm size etc. The Research problem This study investigates the...
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