The Effectiveness of Financial Ratio to Mitigate Information Complexity of Financial Statement for Performance Evaluation

Abstract

Rational and efficient asset allocation and investment decisions in the capital market require relevant and reliable information. One source of information in such decision making in capital market is financial statements. Financial statements, however, provide voluminous and complex information which in turn diminishing the quality of the decision. Based on current studies investors are not fully rational decision maker due to the presence of bounded rationality. To reduce the complexity of information and make a rational decision, investor and financial analyst use financial ratios to evaluate company’s financial performance. This research was aimed to observe whether the use of financial ratio to evaluate company's financial performance can mitigate the investor irrationality in asset allocation and financial decision making. The research sample was the financial statements of company listed on Indonesian Stock Exchange (IDX) during 2015 to 2017. Data were downloaded from Indonesian Capital Market web sites. Correlation analysis used to analyze the effectiveness of 11 financial ratios data. The result of the study indicates the ability of financial ratio describing company’s financial performance. Pearson’s correlation analysis also indicates a significant and high correlation within groups among liquidity ratios, solvency ratios, and profitability ratios. This result shows that some ratios can be simplified and reduced to a simplest and efficient analysis tools.