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RATIO ANALYSIS AS A TOOL OF MONITORING FIRM PERFORMANCE

CHAPTER ONE

INTRODUCTION

1.1.      BACKGROUND OF THE STUDY

The modern banking industry is a convergence point for different interest groups such as Shareholders, Managers, depositors, Employees, Government and her agencies. Inadequate information available to these interest groups sometimes make the exact state of health of the banking sector unrevealed. It is in order to protect these various interest groups with stake in the sector that the government and banking authority have strengthened the legislation to allow for more disclosure of information by these banks. By this, it was felt that various interest groups will have sufficient information about the banks they are dealing with and that such information will help to dictate the native and extent of their dealings with these banks.

However, it has been discovered that this disclosure will not reveal the exact state of health of these banks just as no amount of exposure of a human anatomy will reveal its state of health. For this purpose, certain tools have to be used to diagnose the bank’s exact state of health from the information disclosed by the banks. This diagnosis is called financial analysis or ratio analysis.

Ratio is a mathematical concept that expresses relationship between two figures. The concept of ratio has been established to be very important tool in analyzing and interpreting financial information. Financial ratio analysis is defined as the relationship between financial data in the financial statement to aid in everlasting the financial condition and performance of a firm or business organisation. Performance, have is viewed from the angle of liquidity, profitability and efficiency (Abass, 2004).

The traditional literature of financial statement analysis often emphasizes the desirability of adjustment the bank’s financial ratios to predetermined target (Baruch 1969). In recent years, a considerable amount of research has been directed toward an analysis of the predictive power of financial ratios. Consequently, ratio analysis is a powerful tool of financial analysis. Ratio analysis is an analytical technique in accessing the performance of a business enterprise (Altman, 1968).

Various items of information contained in the balance sheet and profit and loss account of a bank which exhibit some significant relationship can be expressed in terms of each other to obtain a ratio. Once these ratio are obtained, they are analysed in the light of a given standard. These standards may be historical or industrial.

Historical standards are used where the analyst wishes to monitor the performance of a particular entity over a given time or period. While the industrial standard are used where the focus of the analyst is the measurement of the performance of the bank in a given year vis-à-vis the average banks in the same industry (Beejay, 2001).

Because of its flexibility, financial ratio can be used as a tool to analyses all forms of business ownership irrespective of their size, and type. This analysis can be carried out into all aspects of the banking operation. With ratio analysis, the relative size of the bank being compared will not pose much problems. It is one of the few analytical tools that could cater for the interest of all interest groups. The fact is derived from its flexibility, stability of earnings, liquidity, financial risk, coverage of financial charges e. t. c. all these and other factors are what aid the decision of the various interest groups in banking sector.

Over the years, financial manager, as well as bankers, long term creditors (e.g. debenture holder), Suppliers and equity investors find the use of ratio analysis an indispensable tool for X-ray the firms overall performance and prospects of growth.

In view of this, this research work examined “The ratio analysis as a tool of monitoring firm performance in a commercial Bank”.

1.2.      STATEMENT OF THE PROBLEM

It has been discovered that for the past five years that the profits made by First Bank Plc has been on the increase and this can be viewed as an indicator of the good performance of the bank. However, the increase in profit is only in absolute term and may not be indicate of the bank’s superiority in terms of size, growth, liquidity and efficiency.

The specific problems of this study include

1.         The ability of First bank to meet its maturing current and long term obligations.

2.         The ability of the bank to cover its financial charges arising in due course of the business operation.

3.         The ability of the bank to provide returns on its shareholder’s investments.

4.         How effectively are the assets of the bank utilized.

1.3.      OBJECTIVES OF THE STUDY

First Bank Plc is reputed to be one of the best commercial banks in Nigeria and when one looks at the absolute figures reported by the annual report and accounts of this bank: i.e. the deposit base, the savings, the cash reserve, the shareholder’s fund and the balance sheet size, the bank appears to merit the claim of being one of the best and possibly, managed bank in the country (Annual Reports and Account 2000-2005).

However, while it may be safe adjudge the bank as one of the best commercial banks in the country from absolute figure reported by the bank, it may be that safe to reach a conclusion about the quality of the bank’s management. The objectives of this study therefore are:

1.           To evaluate the performance of the bank for the last five years to see what has accounted for the performance shown by the bank.

2.           To evaluate the position of the bank as one of the best among the commercial bank in the country by looking beyond the absolute figures reported i.e. in relative term.

3.           To show that ratio analysis is used as an essential tools in monitoring the performance of the bank.

4.           To provide information for the user of the annual reports and account of First Bank Plc.

1.4.      SIGNIFICANCE OF THE STUDY

This study provide an indepth performance evaluation report which is capable of satisfying the interest of all those who have dealings with the bank in whatever capacity. It is also hope that the study shall avail management of the bank the ample opportunity to compare most effective the performance of their bank over a given period of time i.e. the five years that will be covered by this study. This study shall throw light on how to make use of financial ratio in monitoring of bank’s performance.

1.5.      RESEARCH QUESTION AND STATEMENT OF HYPOTHESIS

The questions to be research under this study will be as follows:

1.           Do your company compute financial ratio?

2.           Does your Bank use Accounting Ratio in its Investment decisions?  

3.           Are Banks mandatorily required by regulation to maintain certain Accounting Ratio?   

4.           Liquidity Ratio measures the ability of the company to meet its current financial obligation as they become due.  

5.           To what extent do accounting ratios provide information for management control and investment decision.

6.           Non publication of financial ratio are of effect to some analyst and users of financial statement.

7.           Ratio analysis could serve as a prediction of business failure.

8.           Is there any problems encountered by analyst in your company in computing Accounting Ratios.

HYPOTHESIS I

Ho:    Ratios are not effective tools for analysing a firm performance.

H1:    Ratio are effective tools for analysing a firm performance.

HYPOTHESIS II

Ho:    The present financial ratios existing in companies have not helped or improved the liquidity or solvency determination, as well as profitability evaluation.

H1:    The present financial ratios existing in companies have helped or improved the liquidity or solvency determination, as well as profitability evaluation.

1.6.      SCOPES AND LIMITATION OF THE STUDY

This study limited its scope to a period of five years, that is 2000-2005. The scope of the study looked into the financial statements of the case study bank and compared its performance with previous years. In addition, the usefulness of ratio analysis as a tool of monitoring performance of the bank was examined.

A major limitation is the inability to obtain sufficient information relating to the study because of the sensibility and confidentiality of required information and inadequate time to carryout extensive research.

1.7.      DEFINITION OF TERMS

1.           Analyst - An executive whose mental orientation is driven by facts, analysis and logic (Koch, 1994).

2.           Accounting Ratio – A ratio can relate any magnitude to any other, such as net profit to total asset or current liabilities to current assets (Helfert, 1994).

3.           Financial statement – These include a large volume of quantitative data supplemented by descriptive note (Welsch and Anthony, 1977).

4.           Reserves – Accounting term meaning an account giving shareholders a claim over some asset of a firm (Koch, 1994).

5.           Liquidity – Refers to a company’s ability to meet its current obligations as they mature (Matulich, 1980).

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