RATIO ANALYSIS AS A TOOL FOR DETERMINING CORPORATE PERFORMANCE ( A STUDY OF SELLECTED BANKS IN NIGERIA) RATIOS ANALYSIS AS A TOOLS FOR DETERMINING CORPORATE PERFORMANCE 🙁 A STUDY OF SELECTED BANKS IN NIGERIA) BEING A RESEARCH PROJECT SUBMITTED TO THE POSTGRADUATE SCHOOL IN PARTIAL FULFILLMENT OF THE REQUIREMENTS FOR THE AWARD OF THE DEGREE OF MASTER OF BUSINESS ADMINISTRATION (MBA) OF AHMADU BELLO UNIVERSITY,ZARIA NIGERIA DEPARTMENT OF BUSINESS ADMINISTRATION, FACULTY OF ADMINISTRATION AHMADU BELLO UNIVERSITY, ZARIA.
NIGERIA TABLE OF CONTENT Title Page Declaration Certification Dedication Acknowledgement Abstract Table of content CHAPTER ONE:INTRODUCTION 1. Introduction 1. Background to the study 2. Statement of the study 3. Research Questions 4. Objectives of the study 5. Formulation of Hypotheses 6. Significance of the study 7. Scope and Limitation of the study 8. Definition of key Terms CHAPTER TWO:THEORETICAL FRAMEWORK AND LITERATURE REVIEW 2. 0Introduction 2. 1Conceptual of financial Ratios 2. 2Classification of financial Ratios 2. 3Significance of Ratio Analysis 2. 4Perspectives of financial Ratios 2. 5Problem of financial Ratios 2. Contemporary issues of financial Ratios 2. 7Theoretical framework CHAPTER THREE:RESEARCH METHODOLOGY 3. 0Introduction 3. 1Research Design 3. 2Population of the study 3. 3Sampling Technique and Sample Size 3. 4Method of Data Collection 3. 5Method of Data Analysis 3. 6Justification of the Method Used CHAPTER FOUR:DATA PRESENTATION AND ANALYSIS 4. 0Introduction 4. 1Brief Historical Background of the selection Banks 4. 2Presentation of Data 4. 3Analysis Data 4. 4Test of Hypotheses 4. 5Discussions on finding and Implication 4. 6Summary of Finding CHAPTER FIVE:SUMMARY CONCLUSIONS AND RECOMMENDATION 5. 1Summary 5. 2Conclusions 5. 3Recommendations
Bibliography Appendices ABSTRACT The main problem faced by financial institutions is the issue of analysing financial statement, which is the subject matter of this research; to what extent could financial ratio analysis serve as a yardstick for evaluating performance? How reliable is the tool in measuring performance? The objective of this study was to determine the extent of reliability of financial ratios in assessing corporate performance in the financial institutions. This study mainly examines the operating performance of first bank of Nigeria Plc, fidelity bank plc, first city monument bank plc using financial ratio analysis.
The study employed documentation to collect the necessary data from secondary source such data were analysed through the use of ratios and descriptive analysis for better understanding. The study found out that based on the period under review, the profit after tax of all the three banks were on the increase which account for the growth of the banks as presently witnessed. Although ratios are computed based on past information, it is concluded that they stand a good yardstick in performance evaluation. Therefore, attempts should be made to expand information base used in the calculation of financial ratios beyond financial report.
CHAPTER ONE INTRODUCTION 1. 0INTRODUCTION This chapter focuses on the background to the study, statement of the problem, research question, objectives of the study, formulation of hypotheses, etc, so that the reader will have a quick grasp of what the chapter is all about. 1. 1BACKGROUND OF THE STUDY To manage a modern business successfully today, rational decisions have to be taken and for a manager to taken this in line with the objectives of the firm, the manager must have analytical tools for analyzing the financial strengths and weaknesses of the firm.
Thus, financial analysis is the starting point for making plans, before using any sophisticated forecasting and planning procedures. It also serves as a means of identifying and establishing relationship between the items of the balance sheet and the profit and loss account. Quite often potential investor and shareholders in a business enterprises desire to have further insight about financial strengthens and weaknesses of the firms so as to determine its corporate performance within a specified period of time.
The basic financial analyses are the balance sheet, trading profit and loss account or income statement, retained earnings statement and sources and uses of funds statement. Management, creditors, investors and in others to form their judgment useful. The analysis of financial statements has been discovered as one of the strategic ways of determining the financial status and corporate performance of the organization, since many believed that the efficient and effective utilization of available finance to a large extent determines the performance of an organization.
Analyzing financial statements typically involves evaluating the past, current and projected performance of the organization and one of such instrument used is the ratio analysis. It involves the interpretation of the financial statement based on some specified standards. The standard of comparison may consist of: Ratios calculated from past financial statement of the same firm. Ratios developed using the projected or proforma financial statement of the same firm. Ratios of some selected banks especially the must progressive and successful at the same point in time.
Ratios of the industry to which the firm belong. When organizations publish their financial statements, the interest of everyone usually centre on how such organizations have performed. But mere looking at the balance sheet alone cannot in most times give clearer report of performance, but financial analyst can make use of ratios analysis to bring out a clearer pictures. This study shall be attempt to analysis ratio as a tool for determining corporate performance of an organization with particular reference to selected banks in Nigeria. 1. 2STATEMENT OF THE PROBLEM.
Some management teams do not possess the required knowledge on how to effectively manage resources hence they give false statement of account to the public about their performance. These problems must have forced financial analyst to ask questions when such financial statements are published. Organization at the commencement of business invest a lot of human and material resources in pursuance of their corporate goals and usually at the end of every financial year, management come up with a statement indicating the financial positions of such organization.
On the surface some of these statements are deceptive as they do not represent a true position of such organization, in some cases investors are mislead, and at the end of the day the organization or the banks goes bankrupt. The question now is; how do we determine an efficient instrument to use in determining corporate performance? This study will attempt to look at these problems and proffer solutions to them. 1. 3RESEARCH QUESTION. The following questions will be addressed in the course of this Study: To what extent does banks management present false statement of accounts to the public?
How financial ratios help in determining the financial positions of Banks? 1. 4OBJECTIVE OF THE STUDY. The main objective of the study is to determine whether ratio analysis can be used as a tool for determining corporate performance of an organization. The following are the specific objectives:- To examine whether banks present false statement of account to the public. To find out whether financial ratio is the best tool for determining the financial positions of Banks. 1. 5FORMULATION OF HYPOTHESES For the purpose of this study the following hypotheses are formulated and stated in the null form with a view of testing them.
Ho:Financial ratio analysis does not have any significant effect in determining corporate performance of an organization. H1:Financial tools used by banks cannot determine the financial positions of the organization. 1. 6SIGNIFICANCE OF THE STUDY A research work of this nature is significance in many ways, firstly, the research will be useful to financial managers and analyst within and outside the organization under study, it would also aid management in general and the finance staff in particular to understand the general issues related to financial analysis and specifically the liquidity position of the firm.
The research is also significance to the academics, it adds more knowledge and challenges or seeks verify opinions earlier propounded, the research is significance in the sense that it expand on how historical data aid to determine and detect trend of business and enables for remedies to be applied promptly. Finally, the research is significance to the banks, because it reminds and keeps them alert on the issues of corporate distress, it is even more significance when one looks at the present economic crisis faced by many banks and other financial institution in Nigeria. . 7SCOPE AND LIMITATIONS OF THE STUDY This study covers financial statements, balance sheet of these banks; first banks Nigeria plc, first city monument bank plc and union bank plc using ratio analysis as a tool for determine their corporate performance. The reason for choosing the above banks is their size,reputation,past record, post capitalization period, strength in the industries from 2005-2010. It is normal with every purposeful research project that in the process of its compilation a lot of limitations do arise. This research project is also not an exception.
The limiting factors are; 1. Unwillingness of the management of all the banks; First Bank of Nigeria Plc, Fidelity bank plc, and First City Monument Bank Plc, to give out their bank’s financial statement to the researcher at the suitable time. 2. Difficulty in getting the prices of shares or the market price of shares from the stock exchange. 3. In comparing these banks with other banks, in the same category, no meaningful result can be achieved because things such as accounting policies, government regulations etc, tend to differ among banks. . Ratios computed are mainly based on the information provided in the annual report, most times point to some problems, which upon investigation may not be true. 5. Also there was problem in getting in touch with some of the top management for more vital information. 1. 8DEFINITION OF KEY TERMS. This study is to enable the uninitiated reader understand the research report more clearly; the researcher defines all key unfamiliar terms or concepts. 1. Annual report: These are document issued annually by the bank to their stakeholders. 2.
Classified financial statements: These are financial statement in which items of the organization report are arranged in groups to assist users in analyzing the statement of account. 3. Current assets: These are organization assets which can easily be turned into cash within a year. 4. Current liabilities: These are organization liability that will normally be repaid within a year. 5. Current ratio: This shows organization ability to cover its current liabilities with its current assets i. e. current assets dividend by current liabilities. 6. Debt ratio: These show the extent to which organizations can be financed by debt. . Earnings per share: These show organization earning per- share which is earning after tax (EAT) divided by the number of common shares outstanding. 8. Fundamental analysis: These show how research used to predict stock value that focuses on such determinants as earning and dividends prospects, expectations for future interest rates, and risk evaluation of the organization. 9. Market share: These show organization percentage of total Naira sales within its industry. 10. Percentage change: It shows the changes in Naira as a result of percentage of the rates of growth or decline of the organization. 11.
Price-earnings ratio: These show the market price per share of organizations common stock divided by the most recent twelve (12) months of earnings per share. 12. Quick Ratio: These show how organization measure of liquidity similar to the current ratio except for exclusion of inventories(cash plus receivables divided by current liabilities) 13. Quick assets: These show organization most liquid current assets (Cash, marketable, securities, and receivables). 14. Return on assets: These measures organization after tax returns on an investment without regard to the manner in which the assets were financed. 15.
Windows dressing: These measures are taken by management of the organization to make business look as strong as possible at the balance sheet date. 16. Operating cycle: These make it easy for organization to repeat it sequence of transactions by which a business generates its revenue and cash receipts from customers. 17. Financial position: Organization shows their financial resources and obligation of the firms, as described in a balance sheet. 18. Public information: These are information which by law are available to the general public, the annual financial statements of publish to the stakeholder of the company. 9. Profitability: These are interest or gain of returns on investment after successful business operations. 20. Responsibility accounting system: Organization designed accounting system to measure the performance of their business units under the control of different managers. CHAPTER TWO THEORETICAL FRAMEWORK AND LITERATURE REVIEW 2. 0 INTRODUCTION This chapter duels on review of previous works, literatures and journals on the subject matter: ratio analysis as a tool for determining corporate performance. 2. 1CONCEPTUAL OF FINANCIAL RATIOS
Van Horne and Wachowicz (2000), present a conceptual of financial ratio analysis that leads itself to situations in which external financial is contemplated as follows:- Analysis of the fund needs of the organization. Analysis of the financial condition and profitability of the organization. Analysis of the business risks of the organization. Determining the financial needs of the organization. Negotiations with suppliers of capital. Ratio analysis is a powerful tool of financial analysis. A ratio is defined as “the indicated quotient of two mathematical expressions” and also “the relationship between two or more things”.
In financial analysis according to Kurfi(2003), a ratio is used as a benchmark for evaluating the financial position and performance of a firm. The absolute accounting figures reported in the financial statement do not provide a meaningful understanding of the performance and financial position of a firm. An accounting figure conveys meanings when it is related to some other relevant information. Ratio helps to summaries large quantities of financial data and to make qualitative judgment about the firms’ financial performance, for example, considers current ratio; it is calculated by dividing current assets by current liabilities.
The ratio indicates a relationship, a quantified relationship between current assets and current liabilities. This relationship is an index or yard stick which permits qualitative judgments to be formed about the firms’ liquidity. The greater the ratio, the greater the firms liquidity and vice verse. The point note is that a ratio reflecting a quantitative judgment. Such is the nature of all financial ratios. Anthony and Reece (1975), opinion that the ratio analysis involves a comparison for a useful interpretation of the financial statements.
A single ratio in itself does not indicate favourable or unfavourable condition. It should be compared with some standard. Standard of comparison may consist of:- Past ratios i. e. ratio calculated from the past financial statement of the same organization. Competitor’s ratio i. e. ratios of selected firms, especially the most progressive and successful at the same point in time. Industry ratios i. e. ratios of the industry to which the firms belong. Projected ratios i. e. ratios developed using the projected or proforma financial statements of the selected firm.
The easiest way to evaluate the performance of a firm is to compare its present ratios with the past ratio; when financial ratio over a period of time are compared, it is known as the time series (or trend) analysis. It gives an indication of the direction of change and reflect whether the firm’s financial performance has improved has improved deteriorate or remained constant overtime. The analyst should not simply determine the change but more importantly he/she should understand why ratios have changed. The changes in the accounting policies without a material change in the organizations performance.
Another way of comparison is to compare ratios of selected organizations in the same industry at the same point in time. This kind of comparison is known as cross – sectional analysis. In most cases, it is more useful to compare the firm’s ratio with ratios of a few carefully selected competitors who have similar operations. This kind of comparison indicates the relative financial position and performance of the organization. An organization can easily resort to such a comparison, as it is not difficult to get the published financial statements of the similar firms (Kennedy and Mc Muller, 1968).
According to Pandey (1999), to determine the financial condition and performance of an organization, its ratios may be compared with average ratios of the industry of which the firm is a member. This sort of analysis helps to ascertain the financial standing and capability of the firm vis-a-vis other firms in the industry. Industry ratios are important standards in view of the fact that each industry has its characteristics which influence the financial and operating relationships. But there are certain practical difficulties in using the industry ratios. First, it is difficult to get average ratios for the industry.
Second, even if industry ratios are available, they are averages – averages of the ratio of strong and weak organizations. Sometimes difference may be so wide that the average may be of little utility. Third, averages will be meaningless and the comparison futile if organizations within the same industry widely differ in their accounting policies and practices. If it is possible to standardize the accounting data for firms in the industry and eliminate extremely weak firms, the industry ratios will prove to be very useful in evaluating the relative financial condition and performance of an organization.
Some times future ratios are used as the standard of comparison. Future ratios can be developed from the projected or proforma financial statements. The comparison of current or past ratios with future ratios shows the firms relative strengths and weaknesses in the past and the future. If the future ratios indicate weak financial positions corrective actions should be initiated. 2. 2CLASSIFICATION OF FINANCIAL RATIO Liquidity ratios are used to judge a firm’s ability to meet short-term obligations from them, much insight can be obtained into the present cash olvency of a company or organization and its ability to remain solvent in the event of adversities, essentially, we wish to compared short-term obligations with the short-term resources available to meet these obligation (Van Horne, 2008:351). Several ratios calculated from the financial statement activity or function to be evaluated. As stated earlier, the parties interested in financial analysis are short and long term creditors, owners and management. Short – term creditor’s main interest is in the liquidity position or the short – term solvency and profitability of the organization.
Similarly owners concentrate on the organization profitability and financial condition. Management is interested in evaluating every aspect of the firm’s performance. They have to protect the interests of all parties and see that the firm grows profitability. In view of the various users of ratios, according to Forster (1986), one may classify the into the following four basic categories:- Liquidity Ratio Leverage Ratio Activity Ratio of Management efficiency Ratio Profitability Ratio.
Liquidity ratios are used to measure the firm’s ability to meet current obligation, leverage ratios shows the proportion of debt and equity in financing assets, activity ratios reflects the firm efficiency in utilizing its assets and profitability ratio measure overall performance and effectiveness of the firm. The above is the most common traditional classification of ratios. However, empirical evidence indicates that ratios can be classified in a variety of ways. Also depending on their beliefs and objectives different authors have classified ratios differently.
LIQUIDITY RATIOS Liquidity is the term used to describe the extent to which an organization can pay its short-term obligations as they fall due. Insolvency is a state of being unable to pay debts as they fall due (Kurfi, 2003: 37). Insolvency may lead to bankruptcy and collapse of a business, investors are unwilling to subscribe for share in or lend money to a firm, which is insolvent and trades are unwilling to supply goods on credit to firm that are always having liquidity problems which may lead the firm’s to become insolvent. It s extremely essential for a firm to be able to meet its obligations as they become due; liquidity ratios measure the ability of the firm to meet its current obligations. Infant analysis of liquidity needs the preparation of cash budgets and cash funds flow statement but liquidity ratios, by establishing a relationship between cash and other current assets to current obligations, provide a quick measure to liquidity. A firm should ensure that it does not suffer from lack of liquidity and also that its does not have excess liquidity.
The failure of a firm to meet its obligations due to lack of sufficient liquidity will result in a poor credit worthiness, loss of creditors Confidence, or even in legal tangles resulting in the closure of the company. A very high degree of liquidity is also bad, idle assets earn nothing. The organizations fund will be unnecessarily tied up in current assets. Therefore, it is necessary to strike a proper balance between high liquidity and lack of liquidity. The assessment of liquidity is done by the following:- Current Ratio
This ratio compares all current liabilities and indicate a firm’s ability to meet its short-term obligations with its current assets. Current Ratio(CR) is given by:- Current Ratio = Current assets Current liabilities As a guide most business firms will require a current ratio of 2:1. Too high ratio will Suggest too much money tied up in current assets, while too low ratio could be dangerous if creditors come and free for quick payment. Quick Acid-Test Ratio or Quick Ratio This is a more conservative measure of liquidity as it excludes inventory from the current assets in determining liquidity.
Quick Ratio(QR) is given by: – Quick Acid-Test Ratio = Current assets – inventories Current liabilities Inventory is excluded from current assets in determining liquidity because in some cases it takes a long time to turn inventory into cash. Cash Ratio This takes tougher view as it examines only cash and its equivalent (i. e. marketable security) to current liabilities. cash ratio is given by:- Cash Ratio = Cash + make table securities Current liabilities This is a measure of the most liquid assets of a firm as it considers only cash and marketable securities in the current assets as the numerator. LEVERAGE RATIOS
Leverage ratio measure the relationship between the funds provided by the owners (shareholders) of a firm and funds provided by the creditors of the firm, they also measure the ability of the bank to service the charges accruing from the used of outsiders fund (creditors). The short-term creditors like bankers and suppliers of raw material are more concerned with the firm’s current debt paying ability. On the other hand, long – term creditors like debenture holders, financial institutions etc are more concerned with the firm’s long-term financial strength. In fact, a firm should have a strong short as well as long term financial position.
To judge the long – term financial position of the firm, financial leverage or capital structure, ratios are calculated. These ratios indicate mix of funds provided by owners and lenders. As a general rule, there should be an appropriate mix of debt and owner’s equity in financing the firm’s assets. The manner in which assets are financed has a number of implications. First between debts and equity, debts are more risky from the firm’s point of view. The firm has legal obligation to pay interest to debt holders, irrespective of the profits made or losses incurred by the firm.
If the firm fails to pay to debt holders in time, they can take legal action against to get payments and in extreme cases can force the firm into liquidation. Second, use of debt is advantageous for shareholders in two ways:- They can retain control of the firm with a limited stake. Their earning will be unmagnified, when the firm earns a rate of return on the total capital employed higher than the interested rate on the borrowed funds. The process of magnifying the shareholder’s return through the use of debt is called “financial leverage” or financing gearing.
However, leverage can work in opposite direction as well, if the cost of debt is higher than the firms overall rate of return, the earnings of shareholders will be reduced. In addition, there is threat of insolvency. If the firm is actually liquidated for non-payment of debt holder’s dues, these worst sufferers will be shareholder, the residual owners. Thus, use of debt magnifies the shareholders’ earning as well as increases their risk. Third a highly debt-burdened firm will find difficulty in raising funds from creditors and owners in future. The owners equity is treated, as a margin of safety by creditors risk will be high.
Thus, leverage ratios are calculated to measure the financial risk and the firms’ ability of using debt to shareholders advantage. Leverage ratios may be calculated from the balance sheet items to determine the proportion of debt in total financing. Many variations of these ratios exist, but these entire ratios indicate the same thing, the extent to which the firm has veiled on debt in financing assets. Leverage ratios are also computed from the profit and loss items by determining the extent to which operating profits are sufficient to cover the fixed charges.
Debt-To- Equity This ratio assesses the extent to which a firm is using borrowed funds; it is computed by dividing the total debt of a firm (including current liabilities) by its shareholders equity. Debt to equity is given by:- Debt-to-equity = Total Debt x 100 Shareholder’s Equity Generally, creditors would like this ratio to be low, because the lower the ratio, the higher the level of the firms financing that is being provided by shareholders and larger cushion(margin of protection) in the event of shrinking asset values or outright losses.
Debt –To-Total Assets This ratio measures the amount of the total funds provided by creditors in relation to the total assets of the firm. Debt to total assets is given by:- Debt-to-total assets = Total Debt x 100 Total Assets Creditors would also prefer low ratio for all debts ratios, because the lower the ratio, the greater the cushion against the creditor’s losses in the event of liquidation. Long-Term Debts To Total Capitalization This ratio measures the relative weight of long term capital to the capital structure (long- term financing) of the firm. ong-term debt-to-total capitalization is given by:- Long-term debt to total capitalization= long-term debt x 100 Total capitalization As this ratio measures the extent to which a firm is financed by long-term loans, the lower the ratio the lower the financial risk of the firm. Times Interest Earned This ratio measures how satisfactorily a firm will meet its interest payment, Time interest Earned is given by:- Times interest Earned = Earnings before interest and tax Interest charges
As this ratio serves as one measure of the firm’s ability to meet its interest payments and thus avoid bankruptcy, the higher the ratio the greater the likelihood that the firm could cover i. e. settle its interest payments without difficulty, it also sheds some light on the firm’s capacity to take on new debt. Fixed charges coverage This ratio is similar to times interest earned ratio, but it is more inclusive in that it recognizes that many firms lease assets and incur long-term obligations under lease contracts for the payment of lease premium.
This ratio is given:- Fixed charge coverage = Earnings before interest and tax + lease obligation Interest charge + lease obligation Nowadays leasing is becoming widespread in financing businesses, this ratio is preferable to the time interest earned ratio for making financial analyses. 2. 2. 3ACTIVITY RATIOS Funds of creditors and owners are invested in various assets to generate sales and profits. The better the management of assets, the larger the amount of sales. Activity ratios are employed to evaluate the efficiency with which the firm’s manages and utilizes its assets.
These ratios are also called turnover ratios because they indicate the speed with which assets are being converted or turned over into sales. Activity ratio, thus, involves a relationship between sales and assets. A proper balance between sales and assets generally reflects that assets are well managed. Several activity ratios can be calculated to judge the effectiveness of asset utilization. Return on capital Employed (ROCE) Is given by:- Return on capital employed= Earned before interest and tax x 100 Capital employed
This is the key ratio as it relates the profit earned to the amount of long term capital invested in the business. It is the test of the efficiency of management in the use of the resources of the firm. Receivable Turnover (RT) Is given by:- Receivable turnover = Annual net credit sales Receivables This ratio provides insight into the quality of the receivables of the firm and how successful the firm is in its collections. Average collection period Debtors collection period or days sales outstanding, all refer to the same ratio, which determines the period of time before receivables are collected after sales.
Average collection period (ACP) is given by:- Average collection period = Receivables x 360 Net sales This ratio assesses the speed with which a firm collects amounts owing from customents. The higher the turnover rate or the lower the collection period the more effective is the control of credit, very high collection periods would indicate that the credit control system needs to be improved and that either incentive should be given to customers for prompt payment or effective sanctions applied against slow payers.
Credit payment period or average payable period Is a ratio that determines a firm’s promptness of payment to supplier or that of a potential credit customer, creditors payment period (CPP) is given by:- Credit payment period = Accounts payment x 360 Annual credit purchases This ratio reveals the average number of days taken in payment of creditors. A higher (than average credit period granted by creditors) ratio will indicate high degree of insolvency. A low ratio indicates an efficient credit payment system. Inventory turnover or stock turnover
Is a ratio that helps in determining how effectively a firm is managing inventory and also to gain an indication of the liquidity of inventory. Inventory turnover is given by:- Inventory turnover = Cost of goods sold Inventory Generally, the higher the inventory turnover, the more efficient the inventory management of the firm and the fresher, more liquid, the inventory. However, sometimes high inventory turnovers indicate a hand to mouth existence. It might therefore, actually is a symptom of maintaining too low a level of inventory and incurring frequent stock-outs (not having enough items in inventory to fill an order).
Relatively low inventory turnover is often a sign of excessive slow moving or obsolete items in inventory. Current assets turnover Is a ratio that seeks to measure how many times the current assets has been generated into sales. Current assets turnover (CAT) is given by:- Current assets turnover = Sales Total current assets Generally, the higher the ratio them more effective the revenue generation of the firm. Fixed assets turnover Is a ratio that reveals the number of times the sales revenue is in relation to the fixed assets that have been employed to generate the revenue.
Fixed asset turnover (FAT) is given by:- Fixed assets turnover = Sales Net fixed assets Generally, the higher the ratio the better for the firm. Total assets turnover This ratio expresses the number of times the value of assets utilized by the firm has been generated into sales. Total assets turnover (TAT) is given by:- Total assets turnover = Sales Total assets Generally, the higher the ratio the better the overall performance of the enterprise. 2. 2. 4PROFITABILITY RATIOS An organization should earn profits to survive grow over a long period of time.
Profits are essentials but it would be wrong to assume that every action initiated by management of an organization should be aimed at maximizing profits, irrespective of social consequences. It is unfortunate that the word “profit” is looked upon as a term of abuse since some firm’s always want to maximize profit at the cost of employees, customers and society, except such un-frequent cases, Drucker (1984), asserts that sufficient profit must be earned to sustain the operations of the business to be able to obtain funds from investors for expansion and growth and to contribute towards social overheads for the welfare of the society.
Profit is the difference between revenues and expenses over a period of time (usually one year) (Kurfi, 2003: 38). Profit is the ultimate “output” of an organization and it will have no future if it fails to make sufficient profits. Therefore, the financial manager should continuously evaluate the efficiency of the organization in terms of profit. The profitability ratios are calculated to measure the operating efficiency of the organization. Besides management of the organization, creditors and owners are also interested in the profitability of the firm.
Creditors want to get interest and repayment of principal rate return on their investment. This is possible only when the organization earns enough profits, profitability is measured by the following ratio:- Gross profit margin This ratio shows the profit relative to sales after the direct production costs are deducted. It can be used as an indicator of the efficiency of the production operation and the relationship between selling price and production costs. Gross profit margin (GPM) is given by:- Gross profit margin = Sales – Cost of goods sold x 100
Sales The gross profit margin reflects the efficiency with which management produces each unit of product. This ratio indicates the average spread between the cost of goods sold and the sales revenue, the higher the ratio the more efficiency of the firms. Mark-ups on cost This is another ratio used to analyze the trading profitability of a firm. It shows the profits relative to direct costs of production. Mark-ups on cost is given by:- Mark-ups on cost = Gross profit x 100 Cost of goods sold This ratio expresses gross profit in different ways, a fall of the two ratio (i. Gross profit and mark-ups on cost) below expectation maybe due to some of the followings factor: reduction in selling prices, poor patronages by customer and poor stock control. Profit margin This ratio helps in measuring the relationship between sales and operating profits. It measures the profit made on sales after all the running expenses have been deducted from the gross profit, if the percentage of this ratio has fallen while gross profit margin has remained constant then increase in running costs should be investigated and efforts be made to reduce them.
Profit margin is given by:- Profit margin = Operating income x 100 Sales If the profit margin is inadequate, a firm cannot achieve satisfactory returns to its investors, because it is an indicator of the ability of a firm to withstand adverse conditions such as fall in prices, rise in costs and declines in sales. Net profit margin This ratio is obtained when operating expenses, interest and taxes are subtracted from the gross profit. Net profit margin is given by:- Net profit margin = Profit after tax x 100 Sales
Net profits margin establishes a relationship between net profit and sales, and indicates managements efficiency in services, administering and selling the producs. Its is a measure of affirms ability to turn each Naira sales into net profit Basic earning power This ratio measures the returns achieved by a firm in relation to its assets. Basic earning power is given by:- Basic earning power = Earnings before interest and tax x 100 Total assets This ratio links the profits generated to the book value of the assets. If a firm is usually its assets efficiently this ratio will be very high.
Return on investment This ratio measures the overall effectiveness of a firm in generating profits with available assets. Return on investment (ROI) is given by:- Return on investment = Net profit after taxes x 100 Total assets This ratio measures the earning power of the invested capital, the higher the ratio the better for the organization. Return on equity This ratio reveals the actual return to shareholders only as payment of interest to long-term lenders has been deducted. Return on equity (ROE) is given by:- Return on equity = Net profit after tax x 100 Shareholders’ equity
This ratio reveals the earning power of a firm on shareholders book value investment comparison should be made with return from other investment to determine the relative worth of that investment. 2. 3 SIGNIFICANCE OF RATIO ANALYSIS The essence of the financial soundness of an organization lies in balancing its goals, commercial strategy, product market choices and resultant financial needs. The company should have financial capability and flexibility to pursue its commercial strategy. Ratio analysis is a very useful analytical technique to raise pertinent questions on a number of anagerial issues. It provides bases or clues to investigate such issues in details. While assessing the financial health of an organization with the help of ratio analysis, answers to the following questions relating to the organization’s profitability, assets, utilizations, liquidity, financing aid strategies capabilities may be sought. In today’s global economy, investment capital is always on the move. Through organized capital markets such as the Nigerian Stock Exchange Investors each day shift billions of investment Naira among different organizations, industries and company.
Capital flows to these areas in which investors expect to earn the greatest returns with the least risks. How do investors forecast risk and potential returns? Primarily by analyzing financial statements. The goal of financial statement is to provide economic decision makers with useful information, financial statements are designed to assist users in identifying key relationships and trends. The financial statements of most publicly owned organizations are classified and presented in “comparative form”.
Often, the word “consolidated” appears in the headings of the statements. Most business organizations prepare classified financial statements meaning that items with certain characteristics are placed together in a group or “classification”. The purpose of these classifications is to develop useful subtotals, which will assist users of the statements in their analyses. These classifications and subtotals are standardized throughout most of Nigerian business, a practice that assists decision makers in comparing the financial statements of different organizations.
In comparative financial statements, the financial amounts for several years appear side by side in vertical columns. This assists investors in identifying and evaluation significant changes and trends. 2. 4PERSPECTIVE OF FINANCIAL RATIO In an attempt to show the importance of ratio analysis, several experts have carried out different research studies and some of their findings and positions are discussed below:- Sauline et al (1958) states that enterprises with deteriorating current ratio default more frequently than those with stable ratio and stable net worth to total assets.
The ratio thus become a good material for evaluation and prediction of business future trend, which determines the financial behaviour of credit applicants. Moore and Akinson (1961) after their research discovered that organizations that always increase their use of credit have high current ratios and working capital to total assets ratios. Their study examines the use of credit as an effective measure of current ratio and working capital asset ratio. Hourigan (1966) regressed rating as dependent variable against the financial ratios of some companies.
He selected and developed a model, the “multiple regression model” which consisted debt, subordination, sales to net worth and new operating income to sales and attempted to predict the top six (6) bond classifications for both moody’s standard and poor and successfully predicted about 58% of moody rating and 42% of standard and pools rating. Patrice (1931) analyzed three to five years condition of twenty firms (that failed between 1920) and 1929 prior to failure by using thirteen ratios for each of them separately and compare his results with those of nineteen non-failed firms.
He then concluded that all ratios are capable of predicting failure to a certain extent. Pinches and Mingo (1973) analyzed eight bonds for the whole of 1967, collected financial data of 35 variables and developed a model that employed six variable group multiple discriminate analysis and factor analysis. The six variables contained in the model are subordination (legal status of the bond), issue size (that is bond ratings and the size of bond issue were related), years of consecutive dividends, net income to total assets and five years long term debt to total assets.
This model obtained 69. 7% success of moody’s actual bond rating. Cludson (1945) discovered that short term liquidity and long-term solvency were the two factors that could be used to differentiate profitable and non-profitable firms when they are classified in their form. 2. 5PROBLEM OF FINANCIAL RATIO The financial ratio analysis is a widely used technique to evaluate the financial position and performance of a business. But there are certain problems in using ratios. The analyst should be aware of these problems. The following are some of the limitations of financial ratios analysis.
It is difficult to decide on the proper basis of comparison. The comparison is rendered difficult because of differences in situations of two companies or of one company over years. The price level changes make the interpretations of ratios invalid. The differences in the definition of items in the balance sheet and the profit and loss statement make the interpretation of ratios difficult. The ratios calculated at a point in time are less informative and defective as they suffer from short –term changes. The ratios are generally calculated from past financial statements and thus are no indicators of future.
Although ratios are widely used to determining corporate financial position and performance of a businesses but they should be used with cautions because they have some limitations. For instance, since ratios are calculated from accounting data which are subject to different interpretations and even manipulations. 2. 6CONTEMPORARY ISSUE OF FINANCIAL RATIOS In an attempt to analyze the financial situation and corporate performance of an organization a lot of contributions has been made so as to provide a more accurate and acceptable tool for analysis corporate performance.
Two of the two important contributions are:- Univariate analysis Multivariate analysis UNIVARIATE ANALYSIS The approach is called (i) Beta analysis, which examines the association between relative risk measures of a security. (ii) A single accounting variable. Given that beta is a co-variability measure, a natural accounting variable to use is the expected co-variability of a firm’s earning with the earnings of all other firms, which is termed as an accounting beta.
Like previously discussed, ratios which are compared with the industry average, the univariate analysis also requires comparing earnings with the earnings of other organizations. Ball and Brown (1969) then examined 26 firms quoted on the New York Stock Exchange (NYSE) first published the univariate analysis over the period 1946 – 1966. Normally, such an analysis is conducted on individual security, but in 1970, Beaver extended the analysis to cover the total portfolio analysis. Beaver and managold (1975), made an extensive research where they sampled 254 compute between 1951 and 1969.
They adopted (4) steps in their analysis. They estimated the market Beta for each firm on monthly return basis all through the period. They estimated the accounting Beta for each firm on annual earnings basis all through the period. They ranked the 254 stocks on the basis of market Beta placing each stock in a portfolio of between five and ten securities and calculated the average market and accounting Beta for each portfolio. They estimated the correlation between the portfolio security markets Beta’s from 3 above.
In their analysis, many conventional accounting variables were used. The following financial variables were conducted with security market Beta’s Earning variability: – Standard deviation of the earnings to price ratio over the period. Dividend – payment ratio: – This was estimated from the index model over the periods. Leverage: – Average debt to total asset ratio over the period was used. MULTIVARIATE ANALYSIS A later development on ratio analysis by Edwin Altman (2008) postulates that a single ratio should not be used to determine the overall financial position of the firm.
Altman through a research he conducted captioned “Financial Ratio: Discrement Analysis and prediction of corporate bankruptcy” reveals the main inadequacies of the traditional financial ratio as a tool as to determining the corporate performance of a firm. He condemned the idea of using a single ratio and suggested instead that multiple ratio be used, this he called “multivariate ratio analysis”. Initially, Altman suggested and used 32 different types of ratios but later reduced them to five (5) and described them as index for indicating the financial condition of a firm Altman defined the index as:
Z = a1 x 1 + a2 x 2 + a3 x 3 ————- an x 3 Where x1 =Working capital Total asset x2=Retain earning Total asset x3= EBIT Total asset x4=Market value of equity Book value of debt x5=Total sales Total asset a1 a2 are constant If ? forms below 1. 81 the firm is classified as bankrupt. If ? fall above 2. 99 the firm is classified to be healthy and where ? falls between 1. 81 and 2. 99 it is called the zone of ignorance. But with later developments, 2,675 were taken as the benchmark. The Altman’s model is considered to be use in the following areas: In predicting the likelihood of firms going bankrupt.
For the purpose of evaluating business loans For the purpose of internal control and investment criteria. 2. 7THEORETICAL FRAMEWORK Information provided by financial statements in summarized form is usually historical in nature and selective; however, it could be used as a guide for future actions by various stakeholders of the organization. According to Kurfi (2003), the various stakeholders do make financial analysis, which is the process of identifying the financial strengths and weaknesses of a firm y properly establishing relationships between the items of the balance and income statement, in order to appraise financial worth of the firm to the firm to take an informed action with respect to the firm. Even though the type of information being sought in making financial analysis by the various stakeholders differ, it could be generally categorized under the following headings: Liquidity, i. e. Ability of the firm to pay its debts and still survive in the long. Performance, i. e. Rightness of decisions made and the quality of management. A guide to future action.
Most “outside” decision makers use financial statements in making investment decisions, that is, in selecting those companies in which they will invest their resources or to which they will extend credit for this reason, financial statements are designed primary to meet the needs of creditors and investors. In this context, creditors include everyone to whom the business owes money. One may become a creditor of a business either by lending it money or by providing goods and services with payment due at a later date. Investors, on the other hand, are those persons having or considering an ownership interest in the organization.
Two factors of concern to creditors and investors are the solvency and profitability of a business organization. Creditors are interested in solvency, the ability of the business to pay its debts as they come due. Business concerns about how to pay their debts promptly are said to be solvent. In contrast, a company that finds itself unable to meet its obligations as they fall due is called insolvency. Solvency is critical to the very survival of a business organization. A business that becomes insolvent may be forced by the courts to stop its operations, sell its assets (for the purpose of paying its creditors) and end its existence.
Investors also are interested in the solvency of a business organization but they are even more interested in its profitability. Profitable operations increase the value of the owners’ equity in the business. A company that continually operates unprofitably will eventually exhaust its resources and be force out of existence. Therefore, most users of financial statements study these statements carefully for clues to the company’s solvency and future profitability. Why should decision makers outside an organization regard financial statements as being fair and reliable?
Three factors have been identified:- Companies internal control structures. The concept of adequate disclosure. Audits performed by independent accounting firms. In Nigeria, Federal laws provide additional assurances as to the reliability of financial statement. The management of a business organization is vitally concerned with the financial position of the business and also with its profitability. Therefore, management is anxious to receive financial statements as frequently and as quickly as possible, so that it may take action to improve areas of weak performance.
Most large organizations provide managers with financial statements on at least a monthly basis. However, mangers have a special interest in the annual financial statements, as these are the statements most widely used by decision makers outside the organization for example, if creditors view the year ended balance sheet as “strong”, they will be more willing to extend credit to the business than if they regard the company’s financial position as weak. A strong balance sheet is one that shows relatively little debt, and large amount of liquid assets relative to the liabilities due in the near future.
Management can and does take steps to make the year ended balances sheet look as strong as possible. For example, cash purchases of assets may be delayed so hat large amounts of cash will be on hand at the balance sheet date. Liabilities due in the near future may be paid, or replaced with longer term liabilities. These actions are called window dressing. Users of year end balance sheet should realize that while these statements are fair and reliable, they do not necessarily describe the typical financial position of the business.
In its annual financial statements, almost every company tries to “put its best foot forward. Many creditors therefore, regard monthly balances sheet as providing a more typical picture of a company’s financial position. CHAPTER THREE RESEARCH METHODOLOGY 3. 0INTRODUCTION This chapter will focus on the research methodology, it explain the population of the study, sampling technique and sample size, method of data analysis and the justification of the method used. In essence it will explain how the research has been carried out by the researcher. 3. RESEARCH DESIGN Generally the research design is intended to specify the methods and procedures for acquiring the information needed to structure the project work and also state the source of such information. The research has used both the exploratory design because they both make the study flexible and they are relevant in identifying relevant variables by interpreting and analyzing existing conditions. 3. 2POPULATION OF THE STUDY According to Osuala (2005), the population of a study is the totality of the observations with which a researcher is concerned.
The population of this study consists of the entire banks in the Nigerian banking sector which are twenty-one (21) in number. 3. 3SAMPLING TECHNIQUE AND SAMPLE SIZE According to Abiola (2006), sampling is the method of selecting a portion of a population for study. The major function of sampling is to obtain external validity. In addition, sampling entails the practical purpose of making possible the study of problems which otherwise could not be undertaken due to cost, time, personnel or scope.
Out of the entire twenty-one banks (21) in the country, the researcher had sampled three (3); first city monument bank, first bank of Nigeria PLC and Fidelity bank PLC using simple random sampling technique. 3. 4METHOD OF DATA COLLECTION This research entails the use of primary and secondary data. Primary data are defined as information collected by the researcher from the field of study. These include data collected through the use of questionnaire, and structured interview. The secondary data are information collected by other agencies but with utility for the research in the researcher’s studies.
In this research, secondary data consist of information from books and other relevant publications (Abiola, 2006). 3. 5METHOD OF DATA ANALYSIS In analyzing the data collected, the qualitative view of the respondents would be outlined and the areas of problems are identified by them would be summarized to provide the basis, for the recommendations to be suggested. Thus, the chi square techniques would be used for the analysis of the data collected and a student (t) test will be carried out at 95% level of significance to determine the validity of the hypothesis earlier formulated. 3. 6JUSTIFICATION OF METHOD USED
No matter how much effort the researcher may put into the statement of his methodology and particularly, in the drawing of samples from the population and design of the study schedule, some imperfections are likely to surface. But for these research work the method used are mainly primary and secondary data because the annual financial report are from the organization while the questionnaires were administered by the researcher. CHAPTER FOUR DATA PRESENTATION AND ANALYSIS 4. 0INTRODUCTION This chapter presents and analyses the data. Ratio analysis is a first step in assessing an entity, which removes ome of the mystique surrounding the financial statements, and make it easier to pinpoint items, which it would be interested to investigate further. The financial statements of a business are analyzed and interpreted to determine its overall position and also to find out about certain aspect of that position, such as earning prospect and debt paying ability. Pandey (2002:108) described financial ratio analysis as “the process of identifying the financial strengths and weaknesses of a firm by properly establishing relationship between the items on the balance sheet and the profit and loss account”.
While Eugene et al (1999:72) viewed ratio analysis as “the systematic production of ratios both from internal and external financial reports so as to summarise the key relationship and result in order to appraise the financial position and performance of the firm. ” Analysis of financial ratios gives a better result when they are prepared consistently and on a regular basis thus, allowing trends to emerge. Ratios prepared for a particular firm that are compared with that of other firms within the same industry are more meaningful.
The examination of the relationship between different items in an accounting statement is most suitably carried out by the calculation of and meaningful interpretation of ratio analysis (James, 2002). According to Altman (1968) in Musa (2005), financial ratio analysis is helpful in determining significant operating and financial characteristics of a firm from accounting data with a view to gaining insight into the operating and financial conditions of the firm and the problem(s) confronting the firm, if any. 4. 1BRIEF HISTORICAL BACKGROUND OF THE SELECTED BANKS
A. FIRST BANK First Bank of Nigeria Plc was founded in 1894 by a shipping magnate from Liverpool, Sir Alfred Jones, the bank commenced as a small operation in the office of Elder Dempster and Company in Lagos. The bank was incorporated as a limited liability company on March 31, 1894, with head office in Liverpool. It started business under the corporate name of the Bank for British West Africa (BBWA) with a paid up capital of 12,000 pounds sterling, after absorbing its predecessor, the African Banking Corporation, which was established earlier in 1892.
This signalled the pre – eminent position, which the bank was to establish in the banking industry in West Africa. In early years of operations, the bank recorded an impressive growth and worked closely with the colonial government in performing the traditional functions of a Central Bank, such as issue of special in the West Africa sub region. To justify its West Africa coverage, a branch was opened in Accra, Gold Coast (Now Ghana) in 1896 and another in Freetown, Sierra Leone in 1898. These marked the genesis of the bank’s international banking operations.
The second branch of the bank in Nigeria was in the old Calabar in 1900 and two years later, services were extended to Northern Nigeria. Changes in the name of the bank also occurred in 1979 and 1991, to First Bank of Nigeria Ltd. and First Bank of Nigeria Plc respectively. FBN got listed on the Nigeria Stock Exchange (NSE) in March 1971 and has won the NSC president’s merit Award nine times for the best financial report in the banking sector. The bank has continued to be a leader in financing long term development of the economy, which was demonstrated in 1947 when the first long term loan was advanced to the then colonial Government.
To demonstrate its commitment to its customers and the development of the Nigerian economy, the bank has since broadened its loan and credit portfolios to various sectors of the economy. First Bank of Nigeria Plc, for over a century, has distinguished itself as a leading banking institution and a major contributor to the economic advancement and development of Nigeria. Currently with 339 branches spread throughout the Federation, the bank maintains the largest network in the industry. B. FCMB BANK First City Monument Bank (FCMB) is a wholesale banking group with a niche retail banking franchise, headquartered in Lagos.
FCMB is the flagship company of the First City Group, one of Nigeria’s leading comprehensive financial services providers. From its early origins in investment banking as City Securities Limited in 1977, FCMB (established in 1982) has emerged as one of the leading financial services institutions in Nigeria, a top 10 bank with subsidiaries that are market leaders in their respective segments. First City Monument Bank Plc (‘the Bank’/’FCMB’) was incorporated as a private limited liability company on 20 April 1982 and granted a banking licence on 11 August 1983.
On 15 July 2004, the Bank changed its status from a private limited liability company to a public limited liability company and was listed on the Nigerian Stock Exchange by introduction on 21 December 2004. The Bank is continuously growing with roughly 1,800 employees, 133 branches and cash-centres spread across every state of the Federal Republic of Nigeria and a presence in the United Kingdom (through its FSA-authorised investment banking subsidiary, FCMB UK) and a representative office in the Republic of South Africa. C. FIDELITY BANK
Fidelity Bank Plc began operations in 1988, as a merchant bank. In 1999, it converted to commercial banking and then became a universal bank in February 2001. The current enlarged Fidelity Bank is a result of the merger with the former FSB International Bank Plc and Manny Bank Plc (under the Fidelity brand name) in December 2005. Fidelity Bank is today ranked amongst the top 10 in the Nigerian banking industry, with presence in the major cities and commercial centres of Nigeria. Over the years, the bank has been reputed for integrity and professionalism.
It is also respected for the quality and stability of its management. Fidelity staffs are also respected in the Nigerian banking industry for the quality of training they receive on the job, as well as in good business schools both in Nigeria and Overseas. The Management is particular about the quality of people that join the system. To qualify as a member of Team Fidelity, a candidate is expected to possess three vital statistics, with the acronym TAC: 1. Talent (an innate mental aptitude) 2. Ambition (a desire to succeed) and 3.
Character (a total quality of integrity which will guide the talent and ambition to productive ends). The Management is focused on building and maintaining a virile and well-respected brand that caters to the needs of its growing corporate, commercial and consumer banking clientele. For this purpose, the bank is leveraging its pedigree in investment banking (Fidelity was a merchant bank for 11years) and its structures and service offerings for a retail populace. Fidelity Bank also enjoys the respect and partnership of a network of off-shore nstitutions with which it has correspondent banking, confirmation lines, credit and other relationships. These include, ANZ London, Afr-eximbank, Cairo, Egypt, ABSA South Africa, Commerce Bank, Frankfurt, Citibank, N. A. London and New York, FBN Bank, UK Ltd, SCB, London, HSBC, US Ex-im Bank, USAID, etc. 4. 2PROFITABILITY IN RELATION TO INVESTMENT Profit is the soul of business but profitability is the life wire of a business. Profitability is synonymous to business success, it adds to the overall value of the company during its operating period, Carleton (1966).
Profit is the difference between the revenue of the business and its expenses over a given period of time; it therefore measures the operating efficiency of the company. Identifying profit, as a concept is not easy, since it can be given several definitions, it can be profit as progress profit, as operating profit, i. e. , earnings before interest and tax, as profit before tax or as profit after tax. The concept of profit used will depend on what is being measured and why. The computations are as follow: A. FIRST BANK (i).
EARNING PER SHARE: The earning per share calculations made over the years indicate whether or not the firm’s earning power on per share basis has changed over that period. [pic] Table 4. 2. (a): | |2009 |2008 |2007 |2006 |2005 | | | N ‘million |N ‘million |N ‘million |N ‘million |N ‘million | |Profit after tax |