FINANCIAL RATIO ANALYSIS AS A BASIS FOR MEASURING CORPORATE PERFORMANCE

TABLE OF CONTENTS Certification i Dedication Acknowledgement iii Table of Content v Lists of Tables Abstract vii iv ii

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 CHAPTER TWO REVIEW OF RELATED LITERATURE 2.1 Historical Development of Financial Statement and Financial Ratios
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2.2 Classification of Ratios 2.2.1 Liquidity Ratio 2.2.2 Profitability Ratio 2.2.3 Leverage Ratio 2.2.4 Activity Ratio 2.3 Practical methods of Financial Ratio Analysis 2.4 Uses of financial Statement vice-a-vice Financial Ratio Analysis 2.5 Limitation of Business Financial Ratio Analysis 2.6 Nature of Financial Statements 2.7 Components of Financial Statement 2.8 Corporate Annual Report 2.9 Miscellaneous sources of Financial and Operating Data 2.10 Various group Interested in Business financial Statements CHAPTER THREE RESEARCH METHODOLOGY 3.1 Introduction 3.2 Area of Study 3.3 Sources of Data 3.4 sample Size and Sampling Techniques 3.5 Measurement of Variables 3.6 Data Analytical Techniques

8 11 14 21 23 26 29 32 35 36 39 40 41

44 44 44 44 45 46

CHAPTER FOUR PRESENTATION, INTERPRETATION AND ANALYSIS OF DATA 4.1 Introduction 4.2 Computation and Presentation of Ratio figures 4.3 Profitability Ratio 4.4 Leverage Ratio
2

47 47 48 50

4.5 Limitation of the Study

51

CHAPTER FIVE SUMMARY CONCLUSION AND RECOMMENDATIONS 5.1 Summary 5.2 Conclusion 5.3 Recommendations Bibliography Appendices Appendix A Appendix B Appendix C LIST OF TABLES Table 4.2.1 Current Ratio for (2003- 2007) Table 4.3.1 Return on Capital Employed (ROCE) for (2002- 2007) Table 4.4.1 Debt-equity-Ratio for (2003- 2007) 47 49 50 53 54 55 57 59 59 60 62

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.

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 Chairmans report, Directors report, Auditors 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
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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 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 companys 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
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financial statement is to indicate weakness or strength in the companys affairs. However, 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 firms viability, efficient utilization of companys resources, firms 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?

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

Intercontinental Bank Plc

United Bank for Africa Plc

Zenith Bank Plc

1.5

Definition of Terms
Financial statements: - It contains summarized information of the firms

financial affairs, organized systematically. They are the means to present the firms financial situation to the users, which is the responsibility of the top management, the statements are contained in a companys 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.

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 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)

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.

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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 Americas 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.

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

11

analysis, the indicator most frequently used was the major current ratio i.e. current asset over current liabilities was believed to indicate the firms 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. 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,

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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 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:
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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. 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.
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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:
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 firms ability of meet its shortterm financial obligations as at when they fall due. Accordingly, attentions are focused on the sizes of the firms reservoir of liquid assets relative to its maturing liabilities.

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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 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.
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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 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.

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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 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 firms 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

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yield an indicator of the firms 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 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

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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 firms 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 firms profitability more meaningfully if he evaluates both.

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
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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 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

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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 firms 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 firms 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. Price earnings ratio = Average price EPS This ratio is a natural extension of the EPS measure, relating the firms 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 firms earnings and its stock prices is firmly investment theory and practice.

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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). a. The proprietors 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

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since they are in effect loan capital. It will be noted that capital, as defined here is indistinguishable to net assets. b. The proprietors 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 by the business. According to Pandeys (2007), there are three variations of the return on capital employed, which are shown as follows:

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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.

viii.

Other Profitability Ratio In addition to the discussed above, the following profitability measures are sometimes suggested in the literature.

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a.

Dividend to net income of payout ratio which measures the percentages of net income distributed to stockholders. This ratio is an indicator of firms dividend policy and is supposed to reflect managements perceptions regarding the uncertainty associated with future earnings.

b.

Operating income to operating assets, which indicates managements 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 nonoperating assets from the denominator is intended to focus on managements 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 firms 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. 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
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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 firms 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 firms capital, the larger the volatility of net earnings, and therefore the higher the financial risk associated with the common stocks.

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
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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 marketbased 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. i. Average Collection Period for Accounts Receivable This measure is computed in two stages: Annual net sales
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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 firms 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 firms accounts receivable; the smaller the measure (i.e. the shorter the collection period) the higher the average liquidity. This aspect of the average collection period ratio is relevant to the evaluation of the firms short-term liquidity position. ii. Inventory Turnover Ratio

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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 firms 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.

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
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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 firms volume of trade

2.3 Practical Methods of Financial Ratio Analysis

Financial ratios are conventionally analyzed in two ways: i. ii. Time-series Cross-sectional analysis The former is concerned with the behavior of a given ratio over time, while the latter involves comparisons between the investigated firms ratio and those of related firms. Both the time-series and cross-sectional) aspects can be combined 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

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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 firms 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 firms ratios with the ratios of view selected 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

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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.

2.4

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

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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 misallocation. An early warning signal of probable failure will enable both
34

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 applicants 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 making comparison. Other relevant information would have to be considered as
35

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 firms economic situations.

36

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

37

ratios. The analyst should be aware of these problems. The following are some of the limitations of financial ratio analysis. a. b. It is difficult to decide on the proper basis for comparison Financial ratios of a company have meaning only when they are compared with some standards c. d. It is difficult to find out a proper basis for comparison 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

38

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.

39

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 companys 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 firms 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.

40

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 owners and retained earnings, auditors; directors and chairmans 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.
41

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. b. a. Fixed assets Current assets 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.

42

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. b. c. a. Long-term Medium-term Short-term 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.

43

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 owners 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:

44

i.

Information on matters considered being of broad interest

relating to overall policies and such general economic trends as might affect the companys 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

45

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
46

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 owners equity (Gearing). c. Examining working capital and equity positions of the business to judge whether borrowed funds and owners 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

47

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

49

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 firms 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)

50

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.

51

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 2003 2004 2005 2006 2007 FBN 1.05:1 1.09:1 1.09:1 1.09:1 1.11:1 GTB 1.11:1 1.01:1 1.23:1 1.13:1 1.08:1 INTL 1.08:1 ** 1.18:1 1.15:1 1.27:1 UBA 1.05:1 1.09:1 1.07:1 1.02:1 1.12:1 ZENITH 0.95:1 0.95:1 1.08:1 1.17:1 1.12:1

Source: 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
52

as 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 dont 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 2003 2004 2005 2006 2007 FBN 34% 53% 34% 35% 24% GTB 33% 29% 15% 21% 15% INTL PLC 37% ** 22% 18% 13% UBA 34% 26% 31% 26% 15% ZENITH 43% 41% 24% 19% 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
54

general view, despite this slight variation in their performance, virtually all of them were 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 2003 2004 2005 2006 2007 FBN 0.3 GTB 0.2 0.2 0.2 0.2 0.2 INTL ** 0.04 0.05 UBA 0.2 0.09 0.03 0.007 ZENITH 0.1 0.2

Source: 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.

55

Gearing of the firm is important because through it, the organization will know if it is 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 owners equity and the margin of the borrowing was low as at when it borrowed with 30%. GTB was financed by owners equity and little borrowing, despite this the owners equity is far greater (80% of owners equity to 30% borrowing). INTL 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

56

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

57

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.

58

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 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

59

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.

60

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.

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: 2 nd Ed. Stecon Publishers, 11 Isikan Akure, Nigeria Aho, 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.

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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 Gartbutt, D (2004): Carters 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. Jennings A. R (1993): Financial Accounting. 2nd Edition: The Guernsey Press, London. Robert O. Igben (2007): Financial Accounting Made Simple, 2nd Edition. ROI Publisher, Lagos Nigeria.

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APPENDICES
APPENDIX (A)

Table 4.2.1 Current Ratio for FBN Plc Years

Current Asset Current Liability Current Ratio

2003 399996 381203 1.05:1

2004 374118 341900 1.09:1

2005 458150 418945 1.09:1

2006 600618 549801 1.09:1

2007 867308 779120 1.11:1

Source: annual report and Account (FBN Plc).

Table 4.2.2
YEARS Current Asset

Current Ratio for GTBANK 2003 N000 87019889 2004 2005 2006 2007 N000 N000 N000 N000 129346802 177110272 296241533 465470086 144268168 262614847 430699094 1.23:1 1.13:1 1.08:1

Current 78550519 118315936 Liability Current 1.11:1 1.09:1 Ratio Source: Annual Report and Account (GTB)

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Table 4.2.3 Current Ratio for Intercontinental Bank Plc

YEARS

Current Asset Current 85478794 ** 167458653 311773807 537603196 Liability Current 1.08:1 ** 1.18:1 1.15:1 1.27:1 Ratio Source: Annual Report and Account (Intercontinental Bank Plc) (**) indicated No Annual Report and
Account for the Year under review.

2003 N000 92394207

2004 N000 **

2005 2006 2007 N000 N000 N000 198111176 357838189 683045516

Table 4.2.4 Current Ratio for United Bank for Africa

YEARS

2003 N000 Current Asset 198275

Current Liability Current Ratio

2004 N000 205645 189106 1.09:1

2005 N000 244607 229664 1.07:1

2006 N000 850946 834167 1.02:1

2007 N000 1141295 1021829 1.12:1

188970 1.05:1

Source: Annual Report and Account (UBA Plc)

Table 4.2.5 Current Ratio for Zenith Bank Plc

YEARS Current Asset Current Liability Current Ratio

2003 N000 106938 112545 0.95:1

2004 N000 183852 193321 0.95:1

2005 N000 314638 291927 1.08:1

2006 N000 585403 501955 1.17:1

2007 N000 936143 834540 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

65

years Net profit Capital Employed ROCE in%

2003 14420 42311 34

2004 14853 27880 53

2005 16808 49805 34

2006 21833 62293 35

2007 25558 105484 24

Source: annual report and Account (FBN Plc).

Table 4.3.2 ROCE for GTBank Plc years Net profit Capital Employed ROCE in% 2003 4210360 12598707 33 2004 4976213 16869179 29 2005 6781108 43583075 15 2006 10488558 49995895 21 2007 15716309 108049018 15

Source: Annual Report and Account (GTB)

Table 4.3.3 ROCE for Intercontinental Bank Plc years Net profit Capital Employed ROCE in% 2003 4139085 11307634 37 2004 ** ** ** 2005 7845694 36188231 22 2006 9787123 55334355 18 2007 22069962 165293966 13

Source: 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 Net profit Capital Employed ROCE in% 2003 5128 14901 34 2004 6010 22918 26 2005 6520 21119 31
66

2006 12811 48835 26

2007 25364 168078 15

Source: Annual Report and Account (UBA Plc)

Table 4.3.5 ROCE for Zenith Bank Plc years Net profit Capital Employed ROCE in%
APPENDIX (C)

2003 5440741 12651577 43

2004 6404885 15674368 41

2005 9154787 37789662 24

2006 15154091 77850665 19

2007 23288828 112833287 21

Source: Annual Report and Account (Zenith Bank Plc)

Table 4.4.1Debt equity Ratio for FBN Plc

Years Total debt Net worth Debt equity ratio 2003 N000 2004 N000 2005 N000 2006 N000 2007 N000

22101 81004 0.3

Source: annual report and Account (FBN Plc).

Table 4.4.1 Debt equity Ratio for GTBank Plc

Years Total debt 2003 N000 2004 N000 2005 N000 2006 N000 2007 N000

1921

3525 11754 0.29

6909 33643 0.2

9237 36349 0.25

58063369 47324118 1.2

Net worth 9638 Debt equity 0.2 ratio

Source: annual report and Account (GTBank Plc).

Table 4.4.1 Debt equity Ratio for Intercontinental Bank Plc

Years 2003 2004 2005
67

2006

2007

N000 Total debt

N000

N000

N000

N000

** ** **

2124 54467 0.04

8605 156889 0.05

Net worth Debt equity ratio

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

Years Total debt Net worth Debt equity ratio

2003 -

2004 3385 19533 0.2

2005 1676 19443 0.09

2006 1135 37304 0.03

2007 1135 156488 0.007

Source: annual report and Account (UBA Plc).

Table 4.4.1Debt equity Ratio for Zenith bank Plc

Years Total debt Net worth Debt equity ratio

2003 -

2004 -

2005 -

2006 409470957 610768300 0.1

2007 595084503 883940926 0.2

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

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