Contents page Introduction……………………page1 Literature review………………page 2 Uses of ratios…………………… Page 2 Types of financial ratios………Page 3 ? Profitability ratios………. Page 3 ? Efficiency Ratios…………. Page 4 ? Liquidity Ratios…………. Page 5 ? Investment Ratios……….. Page 6 Limitations of ratios………….. Page 8 Conclusion…………………….. Page 8 Introduction. The primary purpose of accounting is to convey information about the business to management, investors, shareholders, government and other interested parties. However absolute numbers in isolation are generally meaningless.
The uses of financial ratios enable these figures to be related to other figures so as to put them into perspective. A ratio is a diagnostic tool that helps to identify problem areas and opportunities within a company. Literature Review. Shillinglaw Gordon et al (1979), asserts that the basic building block in financial statement analysis is the ratio, a percentage or decimal relationship of one number to another. Swanson Ross et al (1988), is of the idea that, “Financial analysis is crucial to managers in order to make decisions about operating a business”. The Uses of Financial Ratios. Managers use them to analyse past results to control their business and plan for the future, in budgeting for example. Trends in the same business over a number of years will show whether it is progressing or deteriorating. ? Investors use the ratios to compare their investors with alternative forms of investments. Results in one business may be compared with results of other businesses; this is also known as inter-firm comparison, so as t5o see if it is performing well. ? They are also used by government statisticians who compile tables of national statistics on industry performances. Financial analysts compare ratios against the industry norm, aggregate economy and the economy’s past performance. They would be working for the financial press, trade associations and trade unions. ? Bankers and finance houses also use these ratios to assess the credit worthiness of a business. The Types of Financial Ratios. Financial ratios are very useful to stakeholders. These are individuals and institutions who are interested in the business’s information. The most widely used ratios, by financial analysts, provide insight into a firm’s profitability, liquidity, value and the degree of financial leverage or debt. . Profitability ratios Profitability ratios measure the amount of, and consistency of earnings. This is an important measure of business success. Return on Equity (ROE) =Earnings before tax and profit Total shareholder equity |Premier Bank |Barclays Bank |Stanbic Bank |CABS | |US$ |US$ |US$ |US$ | |-94321 661341 |551738 |6064316 | |7529638 |30792601 |12899373 |30332309 | | | | | | |=-1. 25% |=2. 15% |=4. 78% |=-0. 2% |
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Return on Equity is the measure of return earned on the finance laid out. Premier Bank had a negative percentage of -1. 25%. This simply means that it had a loss. CABS Bank was also unable to make a profit on the equity provided. Stanbic Bank provided the highest percentage showing that it had the greatest return an shareholders funds. ii. Efficiency ratios. Profitability and continued growth of the business are influenced by how efficiently a business utilises its assets. Cost to Income Ratio = Operating Expenses Operating Income Premier Bank |Barclays Bank |Stanbic Bank |CABS | |US$ |US$ |US$ |US$ | |94525 |4986701 |5434714 |2280313 | |2095921 |5423142 |6533492 |917144 | | | | | | |=4. 51% |=91. 95% |=83. 98% |248. 3% | Cost to income ratio is an efficiency measure used to measure how costs are changing as compared to income. The higher the ratio, the higher the firm is incurring losses as compared to income. CABS Bank has the highest ratio of 248. 63% meaning that it is incurring more costs than it is earning income. Premier Bank was the most efficient bank since incurred fewer expenses in relation to income. iii. Liquidity ratios. Liquidity ratios test the ability of assets to cover liabilities. This is the ability of the bank to payback those creditors who are due to be paid in twelve months. Loan to Assets Ratio = Total loans Total assets Premier Bank |Barclays Bank |Stanbic Bank |CABS | |US$ |US$ |US$ |US$ | |5902751 |1625942 |29282853 |4865562 | |19998862 |11662987 |162858378 |47449100 | | | | | | |=29. 52% |=13. 94% |=18. 29% |=10. 25% | Loans to Asset ratio measures the total loans outstanding as a percentage of total assets. The information above shows that Premier Bank has the highest ratio and this means that the bank is more risky to default as compared to other banks. Since Premier bank borrowed more as compared to its assets, it is more likely to payback new loans if it should borrow again. Current Ratio = Current Assets Current Liabilities Premier Bank |Barclays Bank |Stanbic Bank |CABS | |US$ |US$ |US$ |US$ | |4978037 |79894449 |145020269 |4326196 | |4509716 |85837273 |149959005 |4611879 | | | | | | |=1 : 1. 104 |=1 : 0. 931 |=1 : 0. 967 |=1 : 0. 938 | This ratio shows the ability of the bank to payback it liabilities with its current assets. Current liabilities are normally paid from cash on hand and cash that will be imminently received from other more liquid current assets. Current liabilities of Premier Bank slightly surpass current assets meaning that it may need to use other resources to settle it short term obligations. iv. Investment ratios.
Investment ratios are used by investors who are interested in a return of their investment and the value of their shares. Equity to Assets ratio = Shareholders equity Average Total Assets |Premier Bank |Barclays Bank |Stanbic Bank |CABS | |US$ |US$ |US$ |US$ | |7529638 |30792601 |12899373 |30332390 | |[19998862/2] |[116629874/2] |[162858378/2] [47449100/2] | | | | | | |=75. 3% |=52. 8% |=15. 84% |=127. 85% | Equity to Assets ratio is used to analyse the ordinary shareholder capital that may be tied up in assets of the bank. This can be referred to as the capital adequacy of the bank. CABS Bank has the highest ratio. This means that it invested less of its owner’s funds in assets for the bank. Stanbic Bank holds the least ratio meaning that management invests most of the shareholders funds in assets. Interest Cover = Operating income Interest Payments Premier Bank |Barclays Bank |Stanbic Bank |CABS | |US$ |US$ |US$ |US$ | |23097 |514774 |Not given |715252 | |117418 |146567 | |227835 | | | | | | |=0. 1967 times |=3. 512 times | |=3. 139 times | Interest cover measures the number of times a bank is able to pay interest payments in owes from operating income. Barclays Bank is able to pay its interest obligations more times than any other bank. Premier Bank is unable to pay its interest obligations from operating income.
The Limitations of Financial Ratios. ??? Difficulties will arise when making industry average comparison because companies use different accounting methods. For example, depreciation methods used to calculate fixed asset value. ??? Accuracy depends on the quality of information provided in which the ratios are calculated from. The required information is not always disclosed in financial statements. The accounting ratios are as good as the data that they are derived from. ??? Ratios can only be used compare like with like. Firms in the same industry can only be compared since the structures of the firms differ. ??? Ratios ignore the time factor of seasonal businesses.
An example is that banks tend to lend more to farmers during the farming season as compared to other times. ??? Ratios are misleading if they are not adjusted for external factors like inflation. ??? Financial ratios do not take into account non-monetary items like worker competency, morale, motivation or reputation. Conclusion. It is more profitable for an investor to invest in Stanbic Bank. However, Premier bank is operating more efficiently is terms of managing its costs. All the banks except for Premier Bank can settle their short term debts easily with current assets. Lastly, management of CABS tend to invest less in the company’s assets and in the cases of liquidation, ordinary shareholders may be unable to recover their investments.