FINANCIAL RATIO ANALYSIS AS A BASIS FOR MEASURING CORPORATE PERFORMANCE

TABLE OF CONTENTS

Certification i

Dedication ii

Acknowledgement iii

Table of Content v

Lists of Tables vii

Abstract iv

CHAPTER ONE INTRODUCTION

1.1 Background to the study 1

1.2 Statement of the problem 3

1.3 Objectives of the study 4

1.4 Scope of the Study 4

1.5 Definitions of terms 5

CHAPTER TWO REVIEW OF RELATED LITERATURE

2.1 Historical Development of Financial Statement and Financial Ratios 6

2.2 Classification of Ratios 8

2.2.1 Liquidity Ratio 11

2.2.2 Profitability Ratio 14

2.2.3 Leverage Ratio 21

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2.2.4 Activity Ratio 23

2.3 Practical methods of Financial Ratio Analysis 26

2.4 Uses of financial Statement vice-a-vice Financial Ratio Analysis 29

2.5 Limitation of Business Financial Ratio Analysis 32

2.6 Nature of Financial Statements 35

2.7 Components of Financial Statement 36

2.8 Corporate Annual Report 39

2.9 Miscellaneous sources of Financial and Operating Data 40

2.10 Various group Interested in Business financial Statements 41

CHAPTER THREE RESEARCH METHODOLOGY

3.1 Introduction 44

3.2 Area of Study 44

3.3 Sources of Data 44

3.4 sample Size and Sampling Techniques 44

3.5 Measurement of Variables 45

3.6 Data Analytical Techniques 46

CHAPTER FOUR PRESENTATION, INTERPRETATION AND ANALYSIS OF DATA

4.1 Introduction 47

4.2 Computation and Presentation of Ratio figures 47

4.3 Profitability Ratio 48

4.4 Leverage Ratio 50

4.5 Limitation of the Study 51

CHAPTER FIVE SUMMARY CONCLUSION AND RECOMMENDATIONS

5.1 Summary 53

5.2 Conclusion 54

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5.3 Recommendations 55

Bibliography 57

Appendices 59

Appendix A 59

Appendix B 60

Appendix C 62

LIST OF TABLES

Table 4.2.1 Current Ratio for (2003- 2007) 47

Table 4.3.1 Return on Capital Employed (ROCE) for (2002- 2007) 49

Table 4.4.1 Debt-equity-Ratio for (2003- 2007) 50

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ABSTRACT

The study investigated the use of financial ratio as a measure of corporate performance

The general objective of this study is to evaluate the performance of the banks, through

the use of financial ratios, and ascertain their gearing position in assisting user for their

opinion on the performance of an organization which in turn influences their decisions.

The Annual reports and Accounts of the case study namely: FBN Plc, GTBank Plc,

Intercontinental bank Plc, United Bank for Africa Plc and Zenith Bank Plc (2003-2007)

were analyzed and relevant ratios were computed. With the help of these ratios, effective

deductions were made.

Ratios were computed for every aspect of the organization; liquidity ratio, profitability

ratio and leverage ratio were used as variable measured. These ratios reflect the

efficiency with which management utilized the resources at their disposal, this qualifying

financial ratio as an effective measure of assessing the performance of the banks as

corporate organization.

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CHAPTER ONE

INTRODUCTION

1.1 Background to the study

Financial ratios, otherwise called accounting ratios, are widely used for modeling

purposes both by practitioners and researchers. The firm involves many interested parties,

like the owners, management, personnel, customers, suppliers, competitors, regulatory

agencies, and academics, each having their views in applying financial statement analysis

in their evaluations. There are some peculiar items which appear only in the financial

statement of a company. These include Chairman’s report, Director’s report, Auditor’s

report, notes to the account, income statement, balance sheet, cash flow statement, value

added statement, share capital taxation, appropriation account and reserves, and the final

account of the business. These are not produced merely for their own sake, but for the

uses which they can be put by various parties interested in different aspects of the

financial statement. On many occasions, different business organizations take different

decisions that result in either higher or lower profit returns. But before any decision and

prediction about the profit of business is made, the financial manager must have certain

yardsticks for measurement and comparison. One of the most important tools is the

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accounting ratio. The accounting ratio is the proportion or fraction expressing the

relationship between two figures in the same financial statement (Igben, 2007)

Pandey (2007) describes financial ratio as the process of identifying the financial strength

and weakness of a firm by properly establishing relationships between the item of the

balance sheet and the profit and loss account. Financial ratio represents tools for insight

into the performance, efficiency and profit of firm(s). It enables the business

owner/manager to spot the trend in his/her business and compare its performance with

other similar businesses in the same industry. To achieve this, all the business owner

needs to do is to compare his or her firm ratio with the average of businesses similar to

his or hers for several successful years, watching especially for any unfavourable trend

that may be emerging.

Ratio is the indicated quotient of two mathematical expressions and as the relationship

between two or more things. It is used as a benchmark for evaluating the financial

position and performance of a firm. It is a technique for analyzing the relationship

between two items in a company’s financial statements for a given period.

Financial statement is the means of conveying to management and to interested outsiders

a concise picture of the profitability and financial position of a business. This constitutes

a report on managerial performance, attesting to managerial success or failure and

flashing warning signals of impending difficulties. The use of ratio in the interpretation of

financial statement is to indicate weakness or strength in the company’s affairs. However,

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the performance of an organization is measured in terms of its profitability, liquidity and

solvency.

1.2 Statement of the Problem

In business organizations and firms, the knowledge and understanding of a financial

statement by the user can enhance its financial growth and it can also retard it. Therefore,

it is pertinent that the figure appearing in a set of accounts convey considerable

information in terms of their absolute figures. The information in the form of financial

statement is useful to various interest groups. Each user will be interested in the analysis

that will show how well their interest is protected or guaranteed, e.g., determination of

firm‘s viability, efficient utilization of company’s resources, firm’s future prospect, etc.

It is worthy of note that problems are encountered in determining the most appropriate

method by which analysis of financial statement can be made. In spite of this problem,

this study considers financial ratio analysis as a tool which will assist the users in

carrying out a thorough analysis of accounts made by the Directors through which

corporate performance can be measured.

The questions addressed in this study are:

i. Are banks in a position to meet their current obligation?

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ii. Does the use of financial ratio show difference in performance among Banks in

Nigeria?

iii. Does financial ratio show whether banks borrow funds to finance their

operations?

1.3 Objectives of the study

The general objective of this study is to evaluate the financial performance of some banks

in Nigeria. The specific objectives of the study are to:

i. evaluate the performance of Nigerian Banks through the use of financial ratio;

ii. assess the extent to which financial ratio analysis shows difference in the

performance of banks in Nigeria, and

iii. ascertain the use of ratio analysis in determining whether banks borrow to finance

their operations.

1.4 Scope of the Study

This study covered five banks out of the twenty four banks in the country. It is designed

to cover the annual reports and accounts of these banks for a period of five years (2003-

2007). Thus, it is limited to profit and loss account and balance sheet figures found in the

financial statement of account of the following banks:

First Bank of Nigeria Plc

Guaranty Trust Bank Plc

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Intercontinental Bank Plc

United Bank for Africa Plc

Zenith Bank Plc

1.5 Definition of Terms

Financial statements: - It contains summarized information of the firm’s

financial affairs, organized systematically. They are the means to present the

firm’s financial situation to the users, which is the responsibility of the top

management, the statements are contained in a company’s annual report, and it

refers to the profit and loss account and the balance sheet of the company.

Financial ratio: - this is said to mean the relationship between two accounting

figures, expressed mathematically.

Ratio: - is the indicated quotient of two mathematical expressions and as the

relationship between two or more things.

Liquidity: - refers to the ability of a company to have adequate fund or cash or

convertible resources to meet all current liabilities as they fall due.

Solvency: - refers to ability of a business organization to meet its maturing

obligation.

I.M. Pandey (2007)

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CHAPTER TWO

REVIEW OF RELATED LITERATURE

In this chapter relevant materials or literature on the various key subject areas covered by

the study are to be examined. Therefore, the chapter will be broken down to different

sub-headings which comprise both conceptual and empirical study.

2.1 Historical Development of Financial Statement and Financial Ratios

Financial statements analysis is information processing system designed to provide data

for decision making. The information is basically derived from published annual financial

statements and accounts of the companies.

The origin of this financial statements analysis and financial ratios is believed to have

started in the United States. According to Horrigan (2001), the first course of financial

statement analysis could be traced back to the stages of America’s drive to

industrialization in the last half of the Nineteenth century. The major development

created the need for a systematic analysis of companies’ financial data.

The emergence of the corporation as the main organizational firm of business

enterprise, resulting in the separation of management from ownership.

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The fast increasing role of financial institutions (e.g. Banks, investment and

insurance companies) as the major suppliers of capital for business expansion

requiring of formal evaluation of borrowers credit worthiness. Consequently,

analyzing corporate financial data.

The formal is to evaluate operational performance (investment analysis) and the latter to

determine solvency status (credit analysis). The credit analysis function initially dominate

the development of financial statement analysis, statement analysis as banks began using

financial data on a large scale thus, for example, by 1890 it was routine procedure for

commercial bank prospective borrowers for credit evaluation.

The next stage in the development of business financial statements analysis (first decade

of twentieth century) was marked by the use of financial ratios. This is used for the

analysis of financial data. Since credit evaluation was still the major function of financial

analysis, the indicator most frequently used was the major current ratio i.e. current asset

over current liabilities was believed to indicate the firm’s solvency position.

Significant development in ratio analysis between 1900and 1919 can basically be

classified into endogenous and exogenous factors. The formal factors include the

conception of fairly large variety of ratios, the appearance of absolute ratio i.e.2:1

current ratio criteria, the recognition of the need for inter-firm comparison and later for

relative ratio criteria. The exogenous factor centered round the passage of the first federal

income tax code in1913 and the establishment of the Federal Reserve System in 1914,

both in the USA.

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The need for more ratio led Wall to conduct a study in 1912, then he was able to come

up with seven more ratios. At about this time, the notion of using Profit Margins and

turnover was already well developed.

The period between 1920 and 1929 was characterized by extensive data collection and by

the proliferation of new ratios. The decade from 1930 to 1939 witnessed the formation of

Security and Exchange Commission and this resulted in an increase in the Supply of

financial statements and influenced their contents.

In Nigeria, financial ratios can be said to have evolved in three stages. The first stage was

with the advent of financial institution notably the standard Chartered Bank now known

as First Bank. It was established in the year 1884. The second Stage evolved with the

promulgation of the companies in 1968.This streamlined financial reporting in Nigeria,

and the final stage with the advent of the Nigerian Enterprises Promotion Decree of 1972.

Financial ratio on analysis is still in its formative years in Nigeria and due to the dynamic

nature of the economy cannot be absolutely relied upon.

2.2 Classification of Ratios

A central question both in financial ratio analysis research and practice is finding a

parsimonious set of financial ratios to cover the activities of the firm. The main

approaches in this area are fairly clear-cut. They are pragmatically empiricism (a term

coined by Horrigan 1968), a data oriented classification approach, a deductive approach,

and lately, the combination of the last two. An interesting early paper on financial ratios

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which has many of the later issues in an embryonic form can be seen in Horrigan (1965).

Several accounting and finance text-books present a subjective classification of financial

ratios based on the practical experience or views of the authors. It is common that the

classifications and the ratios in the different categories differ between the authors as

pointed out in a tabulation by Courtis (1978, p. 376). In very general terms three

categories of financial ratios are more or less common: profitability, long-term solvency

(capital structure) and short-term solvency (liquidity). Beyond that there is no clear

consensus. Pragmatical empiricism is exemplified by the text-books of Weston and

Brigham (1972), Lev (1974a), Foster (1978, 1986), Tamari (1978), Morley (1984),

Bernstein (1989), White, Sondhi and Fried (1994), Brealey and Myers (1988, Ch. 27),

and handbook chapters such as Beaver (1977), and Holmes and Sugden (1990, Ch 24).

There are several ways of classifying ratios and could be based according to:

i. Source of data

ii. What the ratios are meant to measure

iii. In terms of users for whom they are primarily computed.

According to data source, ratios can be classified into balance sheet ratios, profit and loss

ratios and inter-statement ratios. When two related quantities come from the balance

sheet, both give rise to balance sheet ratio.

In the same vein, when two quantities that are related come from the profit and loss

accounts both give rise to a profit and loss account ratio. An inter-statement ratio on the

other hand is computed by relating items from two different sources.

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Ratios can be classified according to what it is meant to measure vice:

i. As a measure of liquidity. Under this, we have: current ratio, acid test ratio,

receivable turnover ratio.

ii. As a test of profitability. Here we have such ratio as: return on equity, return on

assets, and earnings per share.

iii. As a measure of solvency. This includes: debt equity to total assets, shareholders’

equity to total assets.

iv. As a measure of market performance. This includes, price earnings ratio and

divided yield ratio. It can also be used as:

1. A measure of short-term solvency: current ratio, acid test ratio, stock

turnover, average collection period, average payment period, expenses

percentage.

2. As a measure of profitability and efficiency: gross margin, net profit

percentage, capital employed turnover, return on capital employed,

percentage,

3. Expenses Long term solvency and stability: fixed interest covered, fixed

dividend covered, proprietary ratio, total liabilities to total assets, gearing.

4. Actual/potential growth: earnings per share, dividend per share, price

earnings ratio, earnings yield, dividend yield, dividend cover

Finally, ratio could be classified in terms of the users for whom they are primarily

computed namely:

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i. Ratio basically intended for shareholders: Price earnings ratio, dividend payment

ratio, dividend yield, return of assets, book value per share,

ii. Ratios for short-term creditors: current ratio, acid test/quick ratio, account

receivable turnover, stock turnover.

iii. Ratios for long-term creditors: debt/equity ratio, times interest earned.

One basic fact that must be understood is that there are no hard and fast rules about the

basis classification, rather it is for the purpose of convenience.

2.2.1 Liquidity Ratio

The general objective of liquidity ratios is to indicate the firm’s ability of meet its short-

term financial obligations as at when they fall due. Accordingly, attentions are focused on

the sizes of the firm’s reservoir of liquid assets relative to its maturing liabilities.

Liquidity measures are believed to be prime interest to short term lenders such as banks

and merchandize suppliers.

Current or Working Capital Ratios

i. This ratio is defined as the ratio of current assets to current liabilities. Since

current assets are generally regarded as the reservoir from which maturing

obligations can be paid, it seems reasonable to assume that the larger the current

ratio, the larger the safety margin of short-term creditors.

The attitude of analyst toward the current ratio has changed considerably overtime.

In the early days of financial statements analysis, it was often that the only ratio

used in the evaluation of credit worthiness. Strict standards such as the “two to

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one” (i.e. current assets should be at least twice as large as current liabilities) are

alleged to have been employed by lenders.

However, with the development of financial analysis it became clear that

information additional to that provided by the current ratio, particularly on the

flow of funds, was required for solvency evaluation. This shifted analysts’

attention to more economically meaningful indicators.

ii. Quick or Acid Test Ratio

It is often argued that inventories and prepaid expenses, included in the numerator

of the current ratio can hardly be regarded as liquid assets and hence should be

excluded from liquidity measures.

Accordingly, the quick ratio was suggested to focus on assets that can readily be

used to redeem obligations. The quick ratio includes in the numerator cash,

marketable securities and variables, while the denominator consists of current

liabilities. This ratio therefore provides a stricter test of liquidity than the current

ratio.

iii. Other Liquidity Ratios:

Conventional liquidity indicators, such as the current and quick ratios suffer from a major

shortcoming, which stems from their static structure. Specifically, these ratios reflect the

situation prevailing on the balance sheet date, thereby limiting consideration to the

surplus of current assets over current liabilities at a point in time. However, the

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sufficiency of the liquid assets reservoir at a point in time reflect only one aspect of the

solvency, another, potentially more important solvency aspect is the extent of matching

between periodic cash inflows and outflows. The maintenance of adequate liquidity (and

of course solvency) obviously requires a close matching or synchronization of cash

flows.

A general approach to solvency evaluation should therefore consider the relationship

between cash inflows and outflows throughout the period as well as the size of the

existing liquid assets reservoir.

According to Beaver (1966) a study using powerful statistical techniques was the finding

that current ratio was among the worst predictor of failure and that mixed ratios’ which

has profit or cash flows compared to assets or liabilities, acid test ratios.

Various measures reflecting some aspect of fund flows were suggested for such liquidity

evaluation, for example, the “the internal measure” which compares the quick assets

(cash, marketable securities and receivables) with the average daily flow of cash

expenditure for operations.

The ratio of net working capital to fund provided by operations (the latter defined as net

earnings plus depreciation and other non cash charges). The ratio of funds provided by

operations to current debt.

This various flow-of-funds measures express in different ways to basic notion that for

solvency to prevail, the existing reservoir of liquid assets plus periodic cash inflows

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should cover the outflows by sufficient margin to protect against possible reduction in

inflows of increments in outflows. These measures thus incorporate a dynamic element in

liquidity evaluation.

2.2.2 Profitability Ratios

Profitability ratios are designed for the evaluation of the firm’s performance. The

numerator of the ratios consists of periodic profit according to a specific definition

whilst the denominator represents the relevant investment base. The ratios thus

yield an indicator of the firm’s efficiency in using the capital committed by

stockholders and lenders. The following are some widely used profitability ratios.

i. Gross Profit Margin

The first profitability ratio in relation to sales is the gross profit margin of simply

gross is calculated by dividing the gross profit by sale.

Gross profit margin = Sales – Cost of goods sold

Sales

= Gross profit

Sales

The gross profit margin can be interpreted as reflecting 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. This ratio shows profits

relative to sales after the deduction of production cost and indicates the

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relationship between production cost and selling price. A high gross profit relative

to the industry average implies that the firm is able to produce at relatively lower

cost, which is a sign of good management.

ii. Net Profit Margin

A reasonable gross profit margin is necessary to earn adequate net profit. Net

profit is obtained when operating expenses and income tax are subtracted from the

gross profit. The net profit margin ratio is measured by dividing net profit after tax

by sales.

Net profit margin = Net profit after tax

Sale

Generally, non-operating income and expenses are excluded when this ratio is

calculated. This ratio established a relationship between net profit and sales, and

indicates management efficiency in manufacturing, administering and selling the

products.

This ratio is the overall measure of the firm’s ability to turn each naira of sales into

net profit. If the net profit margin is inadequate the firm will fail to achieve

satisfactory return on owner's equity.

An analyst will be able to interpret the firm’s profitability more meaningfully if he

evaluates both.

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iii. Operating Ratio

The operating ratio is an importance ratio that explains the changes in the net

profit margin ratio. This ratio is computed by dividing all operating expenses; cost

of goods sold, selling expenses, and general expenses by sales.

Operating ratio = COGS + Operating expenses

Sales

A higher operating ratio is unfavorable since it will leave a small amount of

operating income to meet interest, dividends etc. In order to get a comprehensive

idea of the behavior of operating expenses, variations ratios over a number of

years should be studied.

iv. Earnings per Share (EPS)

This is well known and widely used indicator of the performance of a business

enterprises:

E.P.S = Net income

Numbers of outstanding ordinary shares

The numerator is defined as net income after interest, taxes and preferred

dividends (i.e. available for common shareholders), while the denominator

represents the number of common shares outstanding at year-end. The earnings

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per share (EPS) figure play a prominent role in practical investment analysis.

Straight forwardly interpreted, it represents the amount of earnings allocated to

one share of common stock. However, more importance is often imputed to this

measure, for example;

Jaedick and Sprous (2003) refer “the amount of net income remaining after

allowing for the fixed obligation of dividend distributions to preferred

shareholders is a crude but indispensable measure of the increase in well being of

common shareholders. EPS is used as a basis for predicting dividends and growth

and hence future market value of common shares. Indeed, Corporate Managers

often define their policy goals in terms of earnings per share of common stocks”.

Despite its wide use in practice, the EPS figure is often earnings retention

phenomenon. Specifically, since most firms periodically retain a portion of their

earnings, this increases overtime. Consequently, EPS will increase even though

the firm’s profitability of operations has not change or even decreased. According

to Mandelker and Lev (2002), in an empirical study into possible misinterpretation

of EPS changes, they noted, “given the retention phenomenon EPS changes cannot

be directly to changes in firm’s performance”.

v. Price-earning Ratio (P.E.R)

This measure is defined as the ratio of the market price of a common stock

(usually an average price for the period) to its earnings per share.

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Price earnings ratio = Average price

EPS

This ratio is a natural extension of the EPS measure, relating the firm’s earnings to

stock order to answer the question. How much is the investor paying for the EPS?

The belief in the existence of a close relationship between the firm’s earnings and

its stock prices is firmly investment theory and practice.

A strong, successful and promising company usually sells at a higher multiplier of

current or average earnings than one that is less strong, less successful, and less

promising.

The price-earnings ratio conventionally calculated is thus an indicator of the future

earnings prospect of the firm, as anticipated by the market. It should be noted that

cross sectional comparisons of price earnings ratios are unlike those of EPS,

economically meaningful, arbitrary figure of the number of shares is cancelled in

the price earnings ratio.

vi. Return on Capital Employed (R.O.C.E)

This ratio comments on the efficiency of the management by contrasting the profit made

by business with the funds utilized to make that profit. It may be used to show the relative

of the business as compared with the return on capital employed in other comprises in the

same industry, or in different industries, or in another country, or for the same concern in

earlier years. Consideration controversy exists concerning the definition of the term

capital but those generally accepted, are as follows according to Beckett (1982).

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a. The proprietor’s or shareholders interest plus long-term loans or debentures. When

loans are include, it is necessary adding back debenture or loan interest to net

profit in order to compare gross earnings with capital employed. If long-term loans

form a significant part of the funds employed, it seems logical to include these

since they are in effect loan capital. It will be noted that capital, as defined here is

indistinguishable to net assets.

b. The proprietor’s or shareholders’ interest in the case comparison would be with

net before adjustment, in this case.

c. As (b) above less the value of investments, where these are additional to the main

activities of the business, with a view to assessing the return achieved by their

particular field. Supporters of this basis argue that inclusion of investments and

income therefore, vitiates the result by reflecting the ability of the management as

investors. It may be further argued that only non-speculative investments should

be excluded, since trade investments and shares in subsidiary companies (held

primarily protect the goodwill of the concern or further main business) from a

basis argue that management should utilize all the funds at its disposal to

maximize profits, including the selection of investments yielding a high return as

an outlet for surplus funds.

Bryant in his work using the 1981 Companies Act format for companies defined return

on capital employed as the rate of operating profit in total capital employed i.e. the rate of

profit achieved before financing borrowing, divided by the total capital resources utilized

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by the business. According to Pandey’s (2007), there are three variations of the return on

capital employed, which are shown as follows:

Net profit after taxes

i. ROCE = Capital employed

ii. ROCE = Net profit after taxes + interest

Capital employed

iii. ROCE = Net profit after taxes + interest

Capital employed – intangible assets

We have already defined the term capital employed to include permanent capital

minus non-current liabilities plus shareholders equity. Alternatively, it is equal to

working capital plus net assets.

The return on capital employed indicates how well management has used the

funds supplied by creditors and owners. The higher the ratio, the more efficient the

firm in using funds entrusted to it. The ratio should be compared with the ratios of

similar business and the industry average, as this will reveal the relative operating

efficiency of the firm.

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viii. Other Profitability Ratio

In addition to the discussed above, the following profitability measures are

sometimes suggested in the literature.

a. Dividend to net income of “payout ratio” which measures the

percentages of net income distributed to stockholders. This ratio is an

indicator of firm’s dividend policy and is supposed to reflect management’s

perceptions regarding the uncertainty associated with future earnings.

b. Operating income to operating assets, which indicates management’s

efficiency using the operating assets (i.e. total assets excluding investment

in subsidiaries etc). As compared with the net income to total assets ratio,

the exclusion of non-operating income from the numerator and non-

operating assets from the denominator is intended to focus on

management’s performance in the main line of business. This ratio

therefore seems more suitable for firms with a relatively large amount of

non-operating assets, such as holding companies.

2.2.3 Leverage Ratios

The main objective of long-term solvency ratios is to indicate the firm’s ability to meet

both the principal and interest payments on long term obligations. As opposed to the

short-term liquidity ratios, these measures stress the long-run financial and operating

structures of the firm.

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i. Debt-to-Equity Ratio

The numerator of this ratio consists of short-term as well as long-term liabilities

(sometimes even preferred stock) while the denominator consists of stockholders’

equity. This measure of solvency is based on the notion that the larger the ratio of

debt-to-equity, the lower the protection of lenders. This is of course, an

oversimplified approach to the measurement of lenders’ protection.

The debt-to-equity ratio obviously does not distinguish the different degree of debt

protection. However, despite this shortcoming, this ratio widely use as an indicator

of lenders risk.

The debt to equity ratio, indicating the firm’s capital structure (leverage), is also a

measure of the financial risk associated with common stocks. Financial risk is

usually defined in terms of the volatility of the earnings stream that accrues to

common stockholders. It is obvious that for a given fluctuating stream of operating

earnings (i.e. earnings before interest), the larger the fixed amount of interest

charges, the higher the volatility of the residual net earnings to stockholders.

Generally, the higher the relative amount of debt in the firm’s capital, the larger

the volatility of net earnings, and therefore the higher the financial risk associated

with the common stocks.

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ii. Times Interest Earned

This is the ratio of income before interest to periodic interest charges. It is

supposed to indicate the safety margin of the fixed payments to lenders; the higher

the ratio the larger the safety margin since ability to pay interest is examined here,

it seems more appropriate to define the numerator as cash flows (i.e. income plus

depreciation) rather than as income

iii. Other Ratios

Capital structure or degree of leverage is sometimes measured in alternative ways, such

as stockholders’ equity to total capital and total debt in total capital. The specific choice

of leverage measure is a matter of convenience, since they all perfectly correspond to

each other. It should be noted that in the finance literature, degree of leverage is often

measured in terms of market rather than accounting values, that is the total values of

stocks and bonds are based on stock market prices. The accounting-based and market-

based measured of capital structure will usually differ substantially.

2.2.4 Activity Ratio

Activity, efficiency and turnover ratios usually consist of the sales figure in the numerator

and the balance of an asset (e.g. inventory, accounts receivable, etc) in the denominator.

The objective is to indicate various aspects of operational efficiency. Attention is focused

here on specific assets rather than the overall efficiency of assets utilization measured by

the profitability ratios.

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i. Average Collection Period for Accounts Receivable

This measure is computed in two stages:

Annual net sales

a. Average daily net sales = 360 days

Since accounts receivable are involved; it is desirable to use annual credit sales

rather than total sales. However, the breakdown of total sales into the cash and

credit components is usually unavailable in the published financial statements.

With respect to the denominator, different figure (e.g. 250 working days) is

sometimes used. However, as long as consistency (over times and across firms) is

maintain the evaluation.

b. Average Collection Period

Average balance of accounts receivables average daily net sales (from stage 1)

This ratio indicates the average collection period of accounts receivables, or the

average duration from inception to collection of account receivables. It has several

important uses for analyst and management. When compared with the firm’s

policy regarding the credit duration, the ratio indicates the efficiency of the credit.

The average collection period measures also indicates the degree of liquidity of the

firm’s accounts receivable; the smaller the measure (i.e. the shorter the collection

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period) the higher the average liquidity. This aspect of the average collection

period ratio is relevant to the evaluation of the firm’s short-term liquidity position.

ii. Inventory Turnover Ratio

This measure is usually defined as the cost of sales divided by the average

inventory balance. Cost of sales is used rather than sales, since the denominator

(inventories) is generally valued at cost. The inventory turnover ratio is supposed

to indicate the efficiency of the firm’s inventory management, the higher the ratio,

the more efficient the management of inventories. The underlying reason is the

belief that the smaller the inventory level needed to support a given volume of

sales (i.e. the higher the turnover ratio), the better the inventory management. This

is of course an oversimplification, since as well known from inventory theory, a

lower-than-optimal inventory level may be as costly to the firm (in the form of lost

sales high cost caused by hurried production, etc) as higher-than-optimal-balance.

The objective of inventory management is to maintain an optimal inventory level

rather than to minimize it. Consequently, a high inventory turnover ratio does not

necessarily indicate an optimal inventory management. Nevertheless, substantial

changes over time in the inventory turnover and/or systematic deviations from

industry standards may indicate to the analyst the desirability of probing deeper

into the inventory problem.

29

iii. Other Ratios

a. Inventory Holding Period

It is possible to compute a measure indicating the average selling period (in

days) of the inventory; 360 (days) inventory turnover ratio. This measure is

similar to the receivable average collection period and indicate the degree

of liquidity of inventories; the larger the measure, the lower the liquidity.

b. Net Sales to Stockholders’ Equity

This indicates the activity level of stockholders investment on the firm. A

higher than normal ratio, for example, may indicate an excessive volume of

business on a “thin” margin invested capitals.

c. Net Sales to Working Capital

It is supposed to indicate adequacy of the working reservoir in supporting

the firm’s volume of trade

2.3 Practical Methods of Financial Ratio Analysis

Financial ratios are conventionally analyzed in two ways:

i. Time-series

ii. Cross-sectional analysis

The former is concerned with the behavior of a given ratio over time, while the

latter involves comparisons between the investigated firm’s ratio and those of

related firms. Both the time-series and cross-sectional) aspects can be combined

30

into one method (the residual analysis) to be presented below. The preceding

analyses are the univariate mode, that is, the ratios are examined one at a time.

Shifts towards multivariate ratios analysis, in which several measures are

simultaneously considered, seem warranted. Since is generally regarded to be

superior to the univariate analysis.

i. Time Series Analysis

The easiest way to evaluate the performance of a firm is to compare its present ratios with

the past ratios. It gives an indication of the direction of changes and reflects whether the

firm’s financial performance has improve, deteriorate or remain constant over time. Thus,

the Analyst should not simply determine the change, but, more importantly, he should

understand why ratios have changed. Time Series can be determined by various statistical

techniques such as; plotting the data on scatter diagrams, serial correlation and run

analyses, and various transformations of the original data. The optimal prediction model

to be used depends, of course, on the statistical nature of the process generating the ratio

series. However, most processes in business and economic are very complex and the

number of factors with complex integrations involved.

ii. Cross-section analysis

Another way of comparison is to compare ratios of one firm with some selected industry

at the same point in time. This kind of comparison is known as inter-firm analysis. In

most cases, it is more useful to compare the firm’s ratios with the ratios of view selected

31

competitors, who have similar operations. This kind of a comparison indicates the

relative financial position and performance of the firm. A firm can easily resort to such a

comparison, as it may not be difficult to get the published financial statement of the

similar firms.

It is often argued in the financial literature that inter-firm ratio analysis should be

restricted to comparable firms having the similar characteristics. Comparability is

believed to be enhanced if the firms; Belong to the same industry, Are of similar size,

Use similar accounting methods and are located in the same geographical area.

With respect to the industry effect, Foluke (2002) found that the liquidity and turnover

ratios were significantly different among industry groupings. Horrigan (2001)

corroborated these findings with respect to the turnover ratio and also reported significant

difference among industries for the income to sales ratio. The evidence regarding the

firm-size effect ratio was summarized by Horrigan as follows:

Short-term liquidity ratios are related to size of firm in a positive parabolic

manner. That is, the relationship is positive for smaller firms and negative for

larger firms

Long-term solvency ratios are also related to size of the firm in a positive manner.

Capital turnover are vary universally with the size of the firm.

Profit margin ratios vary directly with the size of the firm

Return on investment ratios also vary indirectly with size of the firm.

32

2.4 Uses of Financial Statements viz-a-viz Financial Ratios analysis

i. Financial ratios are used as a technique of predicting the future. The extent to

which financial statements and financial ratios can be relied upon as a measure of

company performance depends largely on its predictive ability relative to the at

hand.

ii. According to Van Borne (2005), this perception is based on either analysis. In

helping him predict future value of a stock, e.g. investors might feel that return on

investment ratio and various profit margin ratios are the most important. Several

empirical studies have been undertaken that depicted promise for statistically

testing the predicting power of financial ratios. In one of those studies Beaver

tested the power of business financial ratios to predict failure. Business financial

ratios when used in business financial statements analysis are thus an information

processing system designed to supply data on firm related economic events. The

number of possible information systems is obviously very large, given the

numerous economic phenomena that can be described, (e.g. profitability, size,

liquidity, market share etc) each of which can be expressed in various ways.

Accordingly, the basic concern of the business financial analyst is to select the

optimal information system(s) for a given purpose that is the system that will lead

the decision maker to make the most preferred action.

iii. The ability to predict corporate failure is important from both the private and

social point of view, since failure is obviously an indication of resource

33

misallocation. An early warning signal of probable failure will enable both

management and inventors to take preventive measures, operating policy changes,

reorganization of financial structure and even voluntary liquidation will usually

shorten the length of time, losses are incurred, and thereby improve both private

and social resources allocation.

iv. The optimal allocation of credit is probably the most important problem-facing

banks. The bank loan analysts must provide loan officers with an evaluation of the

extent of an applicant’s credit risk and assesses the trade-offs among the terms of a

loan such as interest rates, maturity and face value.

v. As a tool for appreciating managerial performance and control. Being one of the

many techniques at the disposal of management as a whole that are concerned with

formation of strategic plans, making of special decisions, controlling of operations

and making of routine decisions. The business financial functions i.e. by plans

fitting the financial capabilities. Through the analysis of business financial

statements, management can infer the causative factors behind financial adversity

and consequently determine what to do rationally. However, business financial

analyst can be ratios to determine past performance of management.

vi. Financial ratios can also be used for inter-firm comparison techniques. The

comparison with external standard by using ratios of other companies of similar

nature and from industry averages is necessitated by availability of ratios. The

state that business is making 20% profit on sales is meaningless without really

34

making comparison. Other relevant information would have to be considered as

the same time. Inter-firm comparison provides a suitable yard stick for measuring

corporate performance through specific ratios as the industry benchmark and in

comparing individual ratios, the industrial average should be calculated, these

standard deviations measured, and the normal distribution of return on capital

employed investigated. This contributes to the awareness of whether the company

is worth being invested in or not.

vii. They can also further be used as a determinant of further financing from the

computer ratios, the management should know if the company is facing liquidity

problem due to unexpected capital expenditure or as a result of the firm

contemplating on embarking on capital project. The decision to be made is

whether the firm should issue more shares in a bid to expand its equity base or

should go on borrowing. According to the American Accounting Association

“accounting reports provide the information by which millions of investors’ judge

corporate investment performance and by reference to which they make

investment decisions. Every day, decisions concerning the allocation of resources

of vast magnitude are made on the basis of accounting information”. The

widespread publication of accounting information in the business financial reports

indicate that many non-accountants also subscribe to the view that financial

information is extensively used by investors. However, skeptics argue that

business financial statements are source of information by no means only

concerning the firm’s economic situations.

35

viii. Financial ratios can be used for investment decision making investors both

shareholders and debenture holders are all concerned in maximizing the returns on

their investment and are usually keen in the ability of the firm to pay dividends

and to redeem the debentures as an when due. Moreover, they are also concerned

in what their holdings will fetch them.

ix. Labour unions seek avenues to get better remuneration on implementation on

already agreed scheme through their bargaining power. Labour unions use

financial rations as a negotiating tool by going through the ratios of their going

concern, they will be able to determine or confirm that the company is capable of

paying additional remuneration.

They therefore get to concerned with ratio dealings with contribution per

employee and sales per employee and assess the overall contribution to the success

of the company, through their analysis of the ROCE. But this is a means to an end,

which in this case is to barging for better working conditioned and remuneration.

x. A financial ratio can be used as a determinant of the efficiency of capital

employed. The efficiency of utilizing the resources of a firm is highlighted by

some ratios. This is done by comparing the net earnings.

2.5 Limitation of Business Financial Ratio Analysis

The financial ratio analysis is a widely used technique to evaluate the business financial

position and performance of a business. But there are certain problems in using financial

36

ratios. The analyst should be aware of these problems. The following are some of the

limitations of financial ratio analysis.

a. It is difficult to decide on the proper basis for comparison

b. Financial ratios of a company have meaning only when they are compared

with some standards

c. It is difficult to find out a proper basis for comparison

d. Usually, it is recommended that ratios should be compared with the

industry averages. But the industry averages are not easily available.

In Nigeria, for example, no systematic and comprehensive industry ratios are computed,

with reference to the under-itemized fundamental reasons.

i. The comparison is rendered difficult because of differences in situations of two

companies, or of one company over years. The situations of two companies are

never the same. Similarly, the factors influencing the performance of a company in

one year may change in another year. Thus, the comparison of the ratios of two

companies becomes difficult and meaningless when they are operating in different

situations.

ii. The price level changes make the interpretations of ratios invalid. The

interpretation and comparison of ratios are also rendered useless by the changing

value of money. The accounting figures presented in the financial statements are

37

expressed in the monetary unit, which is assumed to remain constant. In fact,

prices change over years and as result assets acquired at different dates will be

expressed at different Naira rates in the balance sheet. This makes comparison

meaningless.

iii. The differences in the definitions of items in the balance sheet and the income

statement make the interpretation of ratios difficult. In practice, differences exist

as to the meaning of certain terms. Diversity of views exists as to what should be

included in net worth or shareholders equity, current assets or current liabilities.

Whether preference share capital should be included in debt, or in current

liabilities. Whether presence share capital should be included in debt in calculating

the debt equity ratio? If intangible assets have to be included, how will they be

valued? Similarly, profit means different things to different people.

iv. The ratios calculated at a point of time are less informative and defective as they

suffer from short-term changes. The ratios do not have much use if they are not

analyzed over use years. The ratios at a moment of time may suffer from

temporary changes. This problem can be resolved by analyzing the trends of ratios

over years. Although, trend analysis is more useful but still the analysis is static in

nature. They do not reveal the changes, which have taken place between dates of

two balance sheets. The statement of changes on financial position reveals this

information, but these statements are not available to outside analysts.

38

v. The ratios are generally calculated from past financial statements and thus, are

indicators of the future.

vi. The basis to calculated ratios is historical financial statements. The financial

analyst is more interested in what happens in future, while the ratios indicate what

happen in the past. Management of the company has information about the

company’s future plans and policies and therefore, is able to predict future

happening to a certain extent. But the outside analyst has to rely on the past ratios,

which may not necessarily reflect the firm’s financial position and performance in

future.

vii. According ratios suffer from inadequacy of the source data i.e. published

information variety in definition and information, method of computation and

variety in formulae.

2.6 The Nature of Financial Statements

Financial statements present a periodic review or report on the progress by the

management and deal with the status of the investment in the business as well as the

results achieved during the period under review. This period under review is known as an

accounting period, which is usually one year, but sometimes for a shorter period of time

(Kennedy and Macmullen, 2004).

Financial statements are often referred to as overall general purpose entity statements by

virtue of the appraisal and review purpose, which they serve.

39

By nature, financial statements are historical and as such, they cannot be used for the

purpose of detailed control of individual segments or phases of the business during an

operating cycle.

The final outlook of financial statements is usually a reflection of the combination of

records facts accounting conventions and personal judgments. These judgments and

conventions when applied affect the financial statements materially. Therefore, their

soundness necessarily depends on the competence and integrity of those making

judgments as well as their adherence to generally accepted accounting conventions and

principles.

The foregoing influence the extent to which published accounts could be successfully

used for quantitative decision-making purpose. (American Institute of Certified Public

Accountants Nature of Financial Statements)

2.7 The Components of Financial Statement

The basic components of the published account are the balance sheet and statement of

income and expenditure, statements of owner’s and retained earnings, auditors; directors

and chairman’s reports, funds flow statement and notes to the accounts.

The balance sheet and income statements are functionally complementary; they present a

record of the financial performance of a business enterprise. By nature, they are historical

rather than predictive, unlike the reports and notes to the accounts, which often take

predictive or speculative form.

40

i. The balance sheet

The balance sheet is a classified summary as at particular date, showing the

sources funds controlled by a business, and how is has used these funds. It is

classified into:

Assets-Fixed and current liabilities – long term, medium term and owners’ equity

– share capital and retained earnings. This classifications and grouping of items is

helpful in appraising the current as well as the long-term financial position of the

business.

ii. Assets

Assets are made up of two components:

a. Fixed assets

b. Current assets

a. Fixed assets

Those are semi-permanent properties of the business used to provide goods

or services, rather than being sold in the normal course of business.

They are semi-permanent because they are durable over a considerably long

period of time, after which they may fixtures, equipments, motor vehicles

and landed properties.

41

b. Current assets

These are those assets of the company having an expected lifespan of not

more than one year from the balance sheet date. They are either cash, or in

a form which can easily be converted into cash.

iii. Liabilities

Liabilities are classifiable into:

a. Long-term

b. Medium-term

c. Short-term

a. Long-term liabilities

These are liabilities or obligations on the part of business, representing

semi-permanent capital of the company. Long-term borrowing; for example

is undertaken for fairly long periods’ usually for more than five years.

When payment becomes due, the item will probably be replaced either by

newly share capital or by further long-term borrowing.

b. Medium-term liabilities

These are liabilities whose payments do not exceed a maximum of five

years.

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c. Short-term or current liabilities

Usually, accompanying the balance sheet and income statement, is a

statement of owners equity. This summarizes all changes in the owner’s

equity balance during the financial period. It serves as an additional

function of demonstrating further, the relationship between income

statement and balance sheet.

2.8 Corporate Annual Report

Usually, certain information not necessarily of an accounting nature are considered so

important that they need to be included in the financial statements. These information

take the form of a corporate report. The corporate annual report is one of the most

important sources of financial and operating data for the external analysts over the last

five to six decades. The corporate annual report has generally changed from a formal and

belief technical publication, to an attractive, organized, more voluminous and well

illustrated publication. The most acceptable of these reports presents statistical, operating

and financial facts of the business, so that those interested may intelligently judge results

of current operations, and the financial position of the organization. This could not be

done without all the complications of the technicalities involved in interpreting the other

quantitative accounting data. These also are included in the corporate annual report, a

description of the problems that confront the management and efforts to cope with them.

The report also contains the following:

43

i. Information on matters considered being of broad interest relating to overall

policies and such general economic trends as might affect the company’s

operations.

ii. Subjective explanations from the management of its policies and goals, as these

often are of tremendous value to those who are interested in the organization. In

demonstrating the above, charts and pictures are often used to emphasize specific

facts and activities. Usually, the corporate report contains a summarization for a

number of years (usually five years) balance sheets, income statements, surplus

and dividends data, as well as other items like statistics of production and sales

volume. All of these are aimed at keeping the various interest groups well

informed without subjecting them to the undue task of technically specialized

interpretation requirements.

2.9 Miscellaneous Sources Financial and Operating Data

The national economic magazine and national newspaper and journals supply additional

materials useful in the analysis of specific business. Other governmental agencies also

have made available to the public, detailed annual reports of different types of business.

Related information may also be obtained from commodities and securities and

exchange. In Nigeria, the Securities and Exchange Commission (SEC) is a most

important source or details financial and operating data on business organizations that sell

their commodities in inter-state commerce. Because, relevant government acts have from

time to time required all business organizations whose securities are listed on the stock

44

exchange to submit annual (detailed) reports relating to their financial and operating

positions.

2.10 Various Groups Interested in Business Financial Statements

The various parties interested in financial statements and they are as followings:

i. Management: These are the people operating a business for the owners and who

are directly responsible for its finances and operations. The management that the

most immediate interest in the financial statement of a business as these

statements, together with supplementary detailed managerial internal operating

and statistical reports provide management with a “blueprint” for their corporate

goals. From this may be determined the financial and operating strengths and

weakness of the business.

ii. Regulatory and other Governmental Agencies: Most businesses are required to

submit financial statements and supplementary data in the form of special reports

to various governmental agencies. The most important of these agencies include

the internal Revenue Service Board, Corporate Affairs Commission, Ministry of

Labour and the Securities and Exchange Commission.

iii. Other interested groups are: Trade associations, commodity and securities

exchange inventor, banks, general creditors, employee and competitors, each party

having its own particular interest. In general, the various interest groups having

connections with a business would wish to analyze and interpreted the financial

statements. They would also wish to obtain and analyze supplementary financial

45

and operating data to determine the answers to many varied question. These

questions are directed to give facts on the following issues:

a. Confirmation of the earnings of the business, to ascertain whether a

reasonable return is being yielded on the investment of borrowed funds and

owners’ equity.

b. Examine the result credit position of the company to judge:

- Whether or not the business is in sound financial condition and

whether such condition is improving.

- Whether the amount of cash is in proper proportion to the

requirement of the current volume of the business and whether the

business will be able to pay current debts in the regular course of

business.

- Whether or not the financial structure is well balanced as between

borrowed funds and owner’s equity (Gearing).

c. Examining working capital and equity positions of the business to judge

whether borrowed funds and owner’s equity have been properly,

effectively, appropriately and advantageously employed.

In relation to assets, they would like to assess how the assets have been financed and to

what extent there is an apparent over investment (if any) in fixed assets, receivables and

46

inventories. They would also like to have information on what the valuations

amortization and income policies are in connection with inventories and other assets.

Furthermore, by way to assessing the return on investment, interested parties examine the

divided policy of the company with respect to its trends over the past years and like likely

pattern in the coming years.

From the point of view of the economic market, answers are sought on issues relating to

whether or not the business is having excessive competitors and whether such is likely to

continue. In addition assessment is made regarding the extent to which the business is

affected by the development of substitute products or services.

With regards to the foregoing, information would be required concerning the extent to

business itself is engaging in research and development in an attempt to provide new

products or services and improve the existing ones.

These pertinent issues are of concern to the various interest parties. These issues can only

be correctly assessed where a proper analysis and interpretation is done, of the

information revealed by the data contained in the published accounts.

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CHAPTER THREE

RESEARCH METHODOLOGY

3.1 Introduction

This chapter covers the information on the study area, the various steps and procedure

used in carrying out this study, source of data, sample size and sample techniques,

measurement of variables as well as the analytical techniques of inter-Bank comparison.

3.2 Area of Study

The area of study is the Banking sector of the Nigerian economy. Few out of the

population in the area were selected for the study, the selected samples were FBN Plc,

GTBank Plc, Eko Bank Plc, Union Bank. The design of the study is based on financial

ratio, which attempt to analyze the financial performance of those selected banks.

3.3 Sources of Data

The basic source of data for this research work was secondary data. This data were

obtained from published sources. The avenues through which information are obtained;

Annual report of the selected banks.

3.4 Sample Size and Sampling Techniques

The population of this study is the twenty four banks in the banking sector of Nigerian

economy. These banks can be categorized into two; old generation banks and new

generation banks. Two banks were purposively selected from the old generation banks

48

and three from the new generation banks. This makes the total of five and shows the

(20.8%) banking sector, the banks were First Bank Nigeria Plc, Guaranty Trust Bank Plc,

Intercontinental Bank Plc, United Bank for Africa Plc and Zenith Bank Plc.

3.5 Measurement of Variables

The study is design to measure the performance of the Nigerian Banks through the use of

financial ratio, and the variables to be used in carrying out this study include:

(a) Liquidity ratio which measures the firm’s ability to meet its current commitment as

at when due. To find out this, the below ratio is calculated;

Current ratio = current asset ÷ current liability.

(b) Profitability ratio provides information about management's performance in using

the resources of the business to generate profit. To calculate this we will use;

Return on capital Employed (ROCE) = Net profit ÷ capital employed × 100

Capital employed refers to (Total assets – current liabilities)

(c) Leverage ratios look at the extent that a company has depended upon borrowing to

finance its operations. To calculate this we will use;

Debt-equity-ratio: Total Debt ÷ Net worth (Share Capital+ Reserves)

49

These above mention variables are to be found and computed from Profit and Loss

Accounts and Balance sheet figures in the Annual Report and Account Published for the

selected Banks and deduction are to be drawn based on computation.

3.6 Data Analytical Techniques

Data obtained from annual financial reports were analyzed using descriptive statistics

such as tables and percentages. Ratio analysis was also invoked in measuring corporate

performance of the selected banks.

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CHEPTER FOUR

PRESENTATION, ANALYSIS AND INTERPRETATION OF DATA

4.1 INTRODUCTION

This chapter deals with the analysis and interpretation of the data for this study. Specific

financial ratios were computed for the Banks and comparisons were made among the

years.

4.2 COMPUTATION AND PRESENTATION OF RATIO FIGURES

4.2.1 Liquidity ratio

Liquidity ratios demonstrate a company's ability to pay its current obligations as at when

due. In other words, they relate to the availability of cash and other assets to cover

accounts payable, short-term debts, and other liabilities. Under this ratio, only current

ratio will be analyzed for the banks.

Current Ratio = current asset ÷ current liability

Table 4.2.1 Current Ratio for (2003 - 2007)

Years/Bank FBN GTB INTL UBA ZENITH2003 1.05:1 1.11:1 1.08:1 1.05:1 0.95:12004 1.09:1 1.01:1 * * 1.09:1 0.95:12005 1.09:1 1.23:1 1.18:1 1.07:1 1.08:12006 1.09:1 1.13:1 1.15:1 1.02:1 1.17:12007 1.11:1 1.08:1 1.27:1 1.12:1 1.12:1Source: Survey 2009 (**) indicated No Annual Report and Account for the Year under review.

See Appendix (A) for detailed calculation of this Table.

From the table above, liquidity positions of the selected banks were calculated and

current ratio was adopted. As a conventional rule, the current ratio of 2:1 is considered as

51

an Ideal standard but this is not the same with computation above. As a conventional

rule, the acid ratio is generally accepted to be more correct than the current ratio which

ideally should be 1:1 if it is computed using the above data. Our values remain unaltered

because banks don’t deal with stocks. FBN in 2003 had 1.05:1 in 2004 it was 1.09:1,

2005 was 1.09:1as well, while in 2007 was 1.12:1. GTB in 2003and 2004 had1.11:1 and

1.01:1, 2005 was1.23:1, 1.13:1in 2006 and 1.08:1 in 2007. Intercontinental bank had

1.08:1 in 2003, and in 2005 was 14 months financial report with that the current ratio was

1.18:1, 1.15:1 in 2006 and in 2007 was 1.27:1. UBA had 1.05:1, 1.09:1, 1.07:1 in 2003 to

2005 respectively and 1.02:1 in 2006 and1.12:1 in 2007. Zenith bank had 0.95:1 in 2003

and 2004 respectively, in 2005 it was1.08:1, 2006 was 1.17:1 and 1.12:1 in 2007. These

have shown efficient utilization of fund entrusted to the management, and from the ratios

computed, it can be inferred that capitals are not tied down unnecessarily.

4.3 PROFITABILITY RATIO

Profitability ratios provide information about management's performance in using the

resources of the business. The financial ratio to be computed under this category is:

Return on capital employed (ROCE) = Net profit ÷ capital employed × 100

Capital employed refers to (Total assets – current liabilities)

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Table 4.3.1 Return on Capital Employed (ROCE) for (2003 – 2007)

Year/Bank FBN GTB INT’L PLC UBA ZENITH2003 34% 33% 37% 34% 43%2004 53% 29% ** 26% 41%2005 34% 15% 22% 31% 24%2006 35% 21% 18% 26% 19%2007 24% 15% 13% 15% 21%Source: Survey 2009 (**) indicated No Annual Report and Account for the Year under review.

See Appendix (B) for detailed calculation of this Table.

Table 4.3.1 Return on capital employed may be described as a relative value of

evaluating divisional efficiency by expressing total return as a percentage of total

investment or total profit as a percent of capital employed. It must be noted that there is

no ideal ratio or industrial average. Whenever ROCE is greater than cost of capital, it

pays off’. The table revealed the general performance over the time period. FBN had 34%

in 2003 and the ratio shows an increase to 53% in 2004, 34% in 2004, increase to 35% in

2006 and the trend dropped in 2007 to 24%. This signified that the resources have been

fairly utilized. GTB had 33% in 2003 in 2004 it dropped to 29% and drastically dropped

to 15% in 2005, it later increased to 21% in 2006, dropped to 15% in 2007. Thus, 37% in

2003, the trend fell drastically in 2005 to 22% and it was fallen consistently up to 13% in

2007. UBA started in 2003 with 34% to 26% in 2004 and moved to 31% in 2005 and in

2006 it dropped to 26%, and 2007 to 15%. Zenith bank had 43% in 2003 with slight

decrease in 2004 to 41%, and 24% in 2005, 19% in 2006, with 21% in 2007. On the

general view, despite this slight variation in their performance, virtually all of them were

53

doing well based on the return on capital employed result from the table above indicates

that the management has utilized the funds provided by both creditors and owners. The

higher the ratio, the more efficient the firm is using the fund entrusted to it.

4.4 Leverage Ratios

Leverage ratios look at the extent that an organization has depended upon borrowing to

finance its operations. As a result, these ratios are reviewed closely by bankers and

investors. Most leverage ratios compare assets or net worth with liabilities. A high

leverage ratio may increase a company's exposure to risk and business downturns, but

along with this higher risk also comes the potential for higher returns. Example of the

major measurements of leverage is;

Debt-equity-ratio: Total Debt ÷ Net worth (Share Capital+ Reserves)

Table 4.4.1 Debt-equity-Ratio for (2003 – 2007)

Year/Bank FBN GTB INT’L UBA ZENITH2003 - 0.2 - - -2004 - 0.2 * * 0.2 -2005 - 0.2 - 0.09 -2006 - 0.2 0.04 0.03 0.12007 0.3 0.2 0.05 0.007 0.2Source: Survey 2009 (**) indicated No Annual Report and Account for the Year under review.

See Appendix (C) for detailed calculation of this Table.

From the computation above the banks are financed by combination of debt and equity. 

In this study, we are concerned about gearing, which is the long-run solvency or leverage.

Gearing of the firm is important because through it, the organization will know if it is

54

financed either by the owners’ fund or borrowing. In measuring it, we make use of the

debt-equity-ratio. The above table presents the computation of debt ratio which shows the

extent to which debt financing has been used in business. The computation shows that

FBN went into borrowing in 2007. It means that the company is being financed by

owner’s equity and the margin of the borrowing was low as at when it borrowed with

30%. GTB was financed by owner’s equity and little borrowing, despite this the owners’

equity is far greater (80% of owners equity to 30% borrowing). INT’L Bank did not

borrow to finance its business until 2006 and 2007 and the magnitude was small to

owners’ equity (4% & 5%) respectively. UBA had 20% borrowing in 2004, 9% in 2005,

and 3% in 2006 and in 2007 it was low to an insignificant figure 0.7% of creditors’

equity. Zenith Bank did not finance its business with borrowing until 2006 and 2007 with

10% and 20% respectively. This shows the level of viability of these firms and owners

have contributed more funds than what lenders’ contributed to the business.

4.5 Limitations to the Study

In the course of this research, some constraints were encountered which limited the extent

of the study. The first of such constraints was information. There was insufficient

information in the financial statements used by the researcher.

It is worth mentioning that, financial ratios are generally calculated from past financial

statement and thus, the correctness of these ratios is limited to the nature, volume and

quality of information supplied in the financial statement published. Perhaps, it is suffice

55

to say that the study relied mainly on secondary data. Therefore, any error in the

secondary data, which has not been disclosed, definitely places a limitation on the kind of

inferences that have been made.

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CHAPTER FIVE

SUMMARY, CONCLUSION AND RECONMENDATIONS

5.1 Summary

This research work establishes the use of financial ratio as a basis for measuring

corporate performance of firms using five of the listed Banks in Nigeria; namely: FBN

Plc, GTBank Plc, Intercontinental Bank Plc, United Bank for Africa Plc and Zenith Bank.

In a wide spectrum, the motivation for this study is to evaluate the financial performance

of Nigeria banks. It is clearly evident that every user of financial statement is interested in

the level of performance achieved by organization overtime. The main objective of this

study is to look at how the analysis of financial statement, through the use of financial

ratios is utilized in assisting user for their opinion on the performance of an organization

which in turn may influences their decisions.

The research work covered the period of five years (2003 – 2007). For the purpose of

clarity and good understanding of the concept of financial ratio, types of financial ratio,

importance of analysis, users of the financial ratio, pitfalls and the rest were discussed.

However, financial ratio formulae were used and the financial statement of the selected

banks also used in computation of the relevant ratios.

The data used were basically secondary data and these were Annual report and account of

the selected Banks, Nigeria Stock Exchange factbook. The sample was 20.8% of the

population of the banking sector and this was purposively taken that is two banks from

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old generation banks and three from the new generation banks making five sample sizes.

The analysis was done through the use of ratio computation, simple percentage and tables

for proper understanding of the relevant computed ratios.

It has been noted that most financial analysts or advisors adopt the use of financial ratio

in assessing the performance of organization which include banks in other to advise their

clients. Therefore, the research work confirms the use of ratio analysis as the best

indicator of banks performance among other methods.

5.2 Conclusion

It can be reasonably concluded from this study that the examination of financial

statement through ratio analysis as a basis for measuring corporate performance is viable.

Ratios have been computed for every aspect of the business organization from liquidity

to profitability and to leverage. The ratios have shown how the management teams of

organizations have managed the resources at their disposal to achieve corporate goals.

The accuracy of financial ratio for comparing result would have been enhanced if the

firms adopted uniform accounting policies and financial reporting throughout the period

under consideration

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5.3 Recommendations

As a result of the numerous pitfalls inherent in the calculation structure and interpretation

of financial ratio, it is worthy to mention, that it should not be absolutely relied upon but

used with cautions. However, the following recommendations are made:

The ratio should be used alongside other factors in interpreting accounts. Other

factors include state of the economy (inflation, boom, depression etc) change in

management policies

Calculation of unnecessary ratio should be avoided least interpretation becomes

difficult or meaningless.

For easy inter companies’ comparisons, financial statements should be made more

detailed and unambiguous. In this case, there should be a need for the

establishment of a specialized agency to compute industrial average for the banks

to aid inter firm comparison

The recommendation becomes imperative in view of the fact that NSE does not

have the published annual report of some of the banks. Also, the presentation of

annual reports of these banks in the NSE factbook was not standardized which

hinders meaningful comparison to be made.

Consistency in the application of accounting policies in banking industry should

be made compulsory by the concerned body.

The banks should as a matter of concern show positive response to decline in

financial ratio.

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I hope with time, the user of accounting ratios will have gained so much and the

job of assessing firms’ performance will not be left to the rule thumbs, as a proper

understanding of this tool will make forecasting an easy task.

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BIBLIOGRAPHY

Adebayo, O.O. et al (2003): Research Methodology for Nigerian Student: 2nd

Ed. Stecon Publishers, 11 Isikan Akure, NigeriaAho, T. (1980): "Empirical classification of financial ratios", Management Science

in Finland 1980 Proceedings, ed. C.Carlsson

Aderinwale, A. (1992): Basic Principles of Research Methodology. Opaleye Abodua Printing press

Akindele R. I. Nassar, M. O. and Owolabi, A. A. (2008): Essentials of Research Methodology. OAU Press, Ile-Ife, Osun State, Nigeria

Bayldon, R. Woods, A. and Zafiris, N. (1984):"A note on the pyramid technique of financial ratio analysis of firms’ performance". Journal of Business Finance and Accounting 11/1, 99-106.

Beaver, W. (1977): "Financial Statement Analysis", Handbook of Modern Accounting, eds Davidson, S. and Weil, R., 2nd ed. McGraw-Hill, NY

Bernstein, L. (1989): Financial Statement Analysis: Theory, application, and

Brealey, R., and Myers, S. (1988): Principles of Corporate Finance. 3rd ed. McGraw-Hill, NY

Chen, K. H., and Shimerda, T. A. (1981): "An empirical analysis of useful financial ratios", Financial Management, Spring 1981, 51-60.

Committee for corporate analysis (1990): Corporate analysis of the financial statements: (in Finnish). Painokaari.

Fame, E. F (1999): Foundations of Finance, New York: basic Books.

Foulke, A. R (2002): Practical Financial Statement Analysis. 5th Edition, McGraw Hill. New York.

Frank Wood and Alan Sangster (2002): Business Accounting 1. 9 th Edition. Prentice Hall, NY

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Gartbutt, D (2004): Carter’s Advanced Accounts: 5th Edition, Pitman Publishing Corporation. London

Horrigan S. A. (2004): “A Story of Financial Ratio Analysis” The Accounting review,.

Igben, R. O. (2002): Financial Accounting Made Simple:1st Edition ROI publishers, Lagos Nigeria.

I.M. Pandey (2007): Financial Management, 9th Edition. Vikas Publishing House, New Delhi, China.

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APPENDICES

APPENDIX (A)

Table 4.2.1 Current Ratio for FBN Plc

Years 2003 2004 2005 2006 2007Current Asset

399996 374118 458150 600618 867308

CurrentLiability

381203 341900 418945 549801 779120

Current Ratio 1.05:1 1.09:1 1.09:1 1.09:1 1.11:1

Source: annual report and Account (FBN Plc).

Table 4.2.2 Current Ratio for GTBANK

YEARS 2003N’000

2004N’000

2005N’000

2006N’000

2007N’000

Current Asset

87019889 129346802 177110272 296241533 465470086

CurrentLiability

78550519 118315936 144268168 262614847 430699094

Current Ratio

1.11:1 1.09:1 1.23:1 1.13:1 1.08:1

Source: Annual Report and Account (GTB)

Table 4.2.3 Current Ratio for Intercontinental Bank Plc

YEARS 2003N’000

2004N’000

2005N’000

2006N’000

2007N’000

Current Asset

92394207 ** 198111176 357838189 683045516

CurrentLiability

85478794 ** 167458653 311773807 537603196

Current Ratio

1.08:1 ** 1.18:1 1.15:1 1.27:1

Source: Annual Report and Account (Intercontinental Bank Plc) (**) indicated No Annual Report and Account for the Year under review.

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Table 4.2.4 Current Ratio for United Bank for Africa

YEARS 2003N’000

2004N’000

2005N’000

2006N’000

2007N’000

Current Asset 198275 205645 244607 850946 1141295

CurrentLiability

188970 189106 229664 834167 1021829

Current Ratio 1.05:1 1.09:1 1.07:1 1.02:1 1.12:1

Source: Annual Report and Account (UBA Plc)

Table 4.2.5 Current Ratio for Zenith Bank Plc

YEARS 2003N’000

2004N’000

2005N’000

2006N’000

2007N’000

Current Asset

106938 183852 314638 585403 936143

CurrentLiability

112545 193321 291927 501955 834540

Current Ratio 0.95:1 0.95:1 1.08:1 1.17:1 1.12:1

Source: Annual Report and Account (Zenith Bank Plc)

APPENDIX (B)

Table 4.3.1 Return on Capital Employed (ROCE) for FBN Plc

years 2003 2004 2005 2006 2007Net profit 14420 14853 16808 21833 25558Capital Employed

42311 27880 49805 62293 105484

ROCE in% 34 53 34 35 24Source: annual report and Account (FBN Plc).

Table 4.3.2 ROCE for GTBank Plc

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years 2003 2004 2005 2006 2007Net profit 4210360 4976213 6781108 10488558 15716309Capital Employed

12598707 16869179 43583075 49995895 108049018

ROCE in% 33 29 15 21 15Source: Annual Report and Account (GTB)

Table 4.3.3 ROCE for Intercontinental Bank Plc

years 2003 2004 2005 2006 2007Net profit 4139085 ** 7845694 9787123 22069962Capital Employed

11307634 ** 36188231 55334355 165293966

ROCE in% 37 ** 22 18 13Source: Annual Report and Account (Intercontinental Bank Plc) (**) indicated No Annual Report and Account for the Year under review.

Table 4.3.4 ROCE for UBA Plc

years 2003 2004 2005 2006 2007Net profit 5128 6010 6520 12811 25364Capital Employed

14901 22918 21119 48835 168078

ROCE in% 34 26 31 26 15Source: Annual Report and Account (UBA Plc)

Table 4.3.5 ROCE for Zenith Bank Plc

years 2003 2004 2005 2006 2007

Net profit 5440741 6404885 9154787 15154091 23288828

Capital Employed

12651577 15674368 37789662 77850665 112833287

ROCE in% 43 41 24 19 21Source: Annual Report and Account (Zenith Bank Plc)

APPENDIX (C)

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Table 4.4.1Debt equity Ratio for FBN Plc

Years 2003 N’000 2004 N’000 2005 N’000 2006 N’000 2007 N’000

Total debt - - - - 22101

Net worth - - - - 81004Debt equity ratio

- - - - 0.3

Source: annual report and Account (FBN Plc).

Table 4.4.1 Debt equity Ratio for GTBank Plc

Years 2003 N’000

2004 N’000 2005 N’000 2006 N’000 2007 N’000

Total debt 1921 3525 6909 9237 58063369

Net worth 9638 11754 33643 36349 47324118Debt equity ratio

0.2 0.29 0.2 0.25 1.2

Source: annual report and Account (GTBank Plc).

Table 4.4.1 Debt equity Ratio for Intercontinental Bank Plc

Years 2003 N’000

2004 N’000

2005 N’000

2006 N’000

2007 N’000

Total debt - ** - 2124 8605

Net worth - ** - 54467 156889Debt equity ratio

- ** - 0.04 0.05

Source: annual report and Account (Intercontinental Bank Plc).) (**) indicated No Annual Report and Account for the Year under review.

Table 4.4.1 Debt equity Ratio for UBA Plc

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Years 2003 2004 2005 2006 2007Total debt - 3385 1676 1135 1135

Net worth - 19533 19443 37304 156488

Debt equity ratio

- 0.2 0.09 0.03 0.007

Source: annual report and Account (UBA Plc).

Table 4.4.1Debt equity Ratio for Zenith bank Plc

Years 2003 2004 2005 2006 2007Total debt - - - 409470957 595084503

Net worth - - - 610768300 883940926Debt equity ratio

- - - 0.1 0.2

Source: annual report and Account (Zenith bank Plc).

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