FINANCIAL RATIO AS A TOOL FOR MEASURING PERFORMANCE: A STUDY OF UNITED BANK FOR AFRICA PLC MARINA, LAGOS
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CHAPTER ONE
1.0 Introduction
In today’s global business, where the performance of banks is of interest to corporate stakeholders such as the management, shareholders, investors, creditors/lenders, suppliers, competitors, trade union, fund managers, investors and advisors, high degree of reliability is placed on the company’s financial information. Basically, however, the bank in the emerging markets still remain the most dynamic force and crucial catalysts in the economic growth and development of a nation (Lin, Li and Chu, 2005).
Grunert, et al (2004) opined that considering the increase and consolidation of the banking industries at the level of investment and financial operations; it appears that there is dearth of well-established performance evaluation framework that can be used as benchmark coupled with the vast informational value that are often available which makes the corporate performance evaluation process a complex problem. A stream of research studies have been directed towards the analysis of the predictive power of financial ratios as measures of corporate performance.
Against this backdrop, therefore, this study tends to evaluate the application of financial ratios and performance of bank ratio analysis and their effective application on the balance sheet, income statements and statement of cash flows among others.
1.1 Background to the Study
Financial sector is the backbone of the economy of any country. It works as a facilitator for achieving sustained economic growth through providing efficient monetary intermediation. A strong financial system promotes investment by financing productive business opportunities, mobilizing savings, efficiently allocating resources and makes easy the trade of goods and services.
The evaluation of a banks’ performance usually employs the financial ratio method, because it provides a simple description about the banks’ financial performance in comparison with previous periods and helps to improve the performance of management (Lin et al., 2005). Moreover, the ratio analysis assists in determining the financial position of the bank compared to other banks.
Performance measurement serves as a source of information about financial outcomes and the internal operations shown in an organization’s financial statements. Effective performance measurement is key in ensuring that an organization’s strategy is successfully implemented. It is about monitoring its own predetermined goals or stakeholders requirements (Nam and Jinn, 2000).
Performance measurement is a very important aspect of business activities. The purpose of measuring performance is not only to know how a business is performing but also to enable that business perform better. It helps to improve the performance of an organization so that it may better serve its customers, employees, owners and stakeholders. A performance measurement system enables an enterprise to plan, measure, and control its performance according to a pre-defined strategy (Alam, Raza and Akram, 2011).
Performance measurement can be financial or non-financial. Horngren, Datar and Foster (2006) note that many organizations are increasingly presenting financial and non-financial performance measures for their subunits in a single report called Balance Scorecard. Different Organizations stress different measures in their Balanced Scorecards, but the measures are always derived from a company’s strategy. They stressed that the balance scorecard measures an organization’s performance from four perspectives:- financial perspective, customer perspective, internal“business process perspective and learning and growth perspective.
Banking has become an important feature, which renders service to the people in financial matters, and its magnitude of action is extending day by day. It is a major financial institutional system in Nepal, which accounted for more than 70% (Gopinathan, 2009) of the total assets of all the financial institutions. A profitable and sound banking sector is at a better point to endure adverse upsets and adds performance in the financial system (Horngren, et al 2006).
Gopinathan (2009) has presented that the financial ratios analysis can spot better investment options for investors as the ratio analysis measures various aspects of the performance and analyzes fundamentals of a company or an institution.
Performance evaluation is the important approach for banks to give incentive and restraint to their customers and it is an important channel for enterprise stakeholders to get the performance information (Bhargava, Dubelaar and Scott, 1998). The performance evaluation of a commercial bank is usually related to how well the bank can use its assets, shareholders’ equities and liabilities, revenues and expenses. The performance evaluation of banks is important for all parties including depositors, investors, bank managers and regulators.
Lambert (1986) notes that non-financial measures are often used for performance evaluation. They are especially relevant on the available financial performance measures not completely reflected on the manager’s contribution to the firm’s total value. He added that the non-financial performance measures serve as an indicator of the firm’s long term performance and may therefore be included in incentive contracts.
Kanodia (1993) argues that financial measure of performance is very crucial as it serves as a tool of financial management, a major objective of a business organization, and a mechanism for motivation and control within an organization.
1.2 Statement of the Problem
Financial ratio is laced with so many challenges that can serve as setback to organization’s financial performance. To this end, the problem of the study however lies in the usage of the financial ratios in analyzing banks financial performance considering the fact that most of these banks do not employ the Generally Accepted Accounting Principle (GAAP) in the preparation of their financial statements. It is worthy of note however, that the use of financial statements in decision-making is not always easy owing to the following problems:
One of the challenges faced in financial ratio analysis is lack of comparability between banks. It is difficult to infer organizational performance from one or two simple numbers. Bank’s choice of accounting policies used in its financial statements will impact its ratios. If, for example, a company uses a last-in-first-out valuation, its ratios that include inventory will be significantly different than a company that uses first-in-first-out. The ratios will not be comparable because the valuations are not comparable.
In view of the summarized nature of the information contained in the financial statements, they need to be analyzed and interpreted by means of financial ratios to enable management and stakeholders understand them and make well-informed business decisions.
Many users of financial statements are not knowledgeable about accounting ratios and how the ratios can be applied on banks using financial statements.
Ratios Based on Book Value is one of the problems of financial ratios because the financial statements are prepared based on book value (largely historical cost), they do not reflect current reality in the business. Ratios that are based on these historical numbers may not be telling the whole story about the health of the company. This is especially true for asset-based ratios. Assets may be worth more or less than the value carried on the balance sheet. If the company is in financial distress, the liquidation value of those assets will be the most relevant.
Financial ratio is also faced with problem of measurement of management quality. Financial ratios, like the financial statements do not capture all of the important information that tells stakeholders how the business is doing today and helps them predict where it is going in the future. One of the key determinants of business success is the quality and experience of the management team. This information cannot be derived directly from financial ratios although large ratio swings can give an indication.
1.3 AIM AND OBJECTIVES OF THE STUDY
The following are the aims and objectives of the study:
- To find out the effect of financial ratio on the overall of performance of banking industry.
- To evaluate if Market-to-book ratio (MB) aids the measuring of Banks performance and making quick comparisons with competitors.
- To know if financial ratio helps Banks in yielding dividend per annum.
- To examine the influence of financial ratio on organization cash flow.
1.4 Research Questions
Based on the purpose of the study, the following questions are raised to provide a guide and solution to the research problems:
- How does financial ratio on affect the overall of performance of banking industry?
- Does Market-to-book ratio (MB) aids the measuring of Banks performance and making quick comparisons with competitors?
- Does financial ratio helps Banks in yielding dividend per annum?
- Does financial ratio affects organizational cash flow?
1.5 Research Hypotheses
In carrying out this research work these hypothetical statements are made to serve as a direction on which the work will be premised.
Ho: There is no significant relationship between financial ratios and performance of banks.
H1: There is significant relationship between financial ratios and performance of banks
1.6 Significance of the Study
The findings of the study will help banks to use financial ratios as a quantitative analysis tool used for the evaluation of management’s performance. It will provide a detailed, accurate picture of the banks’ financial performance. Banks and lenders also use financial ratios to review small business financial information.
The study can help business owners in a comparative analysis to review their company financial ratio indicators against a competing company or the industry standard.
The findings of the study will inform banks in developing mechanisms for hedging such exposure by developing interest rate risk mitigation guidelines. It will help to prepare financial analysts against exchange rate risk serving as precautionary guide in their financial dealings.
Finally, the study forms a basis for future researchers and academicians who may be conducting research on financial ratio on related financial sector indicators or instruments.
1.7 Scope and Delimitation of the Study
The study examines financial ratio as a tool for measuring performance with a view to explore United Bank for Africa Plc, Marina, Lagos. The study will put into consideration the performance among commercial banks and the relationship between bank specific factors (Ratios) on the banks’ performance. The following financial ratio variables will be put into consideration: return on assets (ROA), return on equity (ROE), capital adequacy ratio (CAR)，non performing loan ratio (NPL), net interest margin (NIM), credit to deposit ratio (CDR).
Some perceived constraints may be encounter by the researcher in the course of carrying out the research work. The limitations are as follows:
- Inadequate material: Inadequate material constituted one of the limitations of the research work. The non-availability of materials like journals, textbooks etc the research study.
- Finance: The researcher also may encounter some financial constraints which will contribute in limiting the work in the sense that fund available was not enough to carry out the research to a logical conclusion.
- Time: Time is also another factor or limitation that may affect the research work. The limited time may not give the researcher enough opportunity to do more rigorous work.
1.8 Definition of Terms
Financial Ratio: A financial ratio (or accounting ratio) is a relative magnitude of two selected numerical values taken from an enterprise’s financial statements
Asset: In financial accounting, assets are economic resources. Anything tangible or intangible that is capable of being owned or controlled to produce value and that is held to have positive economic value is considered an asset.
Bank: An institution which accepts deposits, makes business loans, and offers relatedservices.
Economy: The wealth and resources of a country or region, esp. in terms of the production and consumption of goods and services.
Interest Rate: An interest rate is the rate at which interest is paid by borrowers for the use of money that they borrow from a lender.
Price-Earning Ratio: A valuation ratio of a company’s current share price compared to its per-share earnings.
Market to Book Ratio: A ratio used to find the value of a company by comparing the book value of a firm to its market value.
Dividend yield: This is used to calculate the earning on investment (shares) considering only the returns in the form of total dividends declared by the company during the year.
REFERENCES
Bhargava, M., Dubelaar, C. and Scott, T. (1998). Predicting bankruptcy in the retail sector: an examination of the validity of key measures of performance, Journal of Retailing and Consumer Services, Vol. 5, No. 2, pp. 105-117.
Grunert, J. Norden, L. and Weber M. (2004), The role of nonfinancial factors in internal credit ratings, Journal of Banking and Finance, No. 29, pp. 509-531.
Nam, J-H. and Jinn, T. (2000), Bankruptcy prediction: Evidence from Korean Listed Companies During the IMF Crisis, Journal of International Financial Management and Accounting, Vol. 11, No. 3, pp. 178-197.
Lin, W. C., Li, C. F. and Chu, C. W. (2005). Performance efficiency evaluation of the Taiwan’s shipping industry: an application of data envelopment analysis. In: proceedings of the Eastern Asia Society for Transportation Studies, 5: 467-476.
Alam, H.M., Raza, A. and Akram, M. (2011). A financial performance comparison of public vs private banks: The case of commercial banking sector of Pakistan. Int. J. Bus. Soc. Sci., 2(11): 56-64.
Horngren, C. T., Datar, S. M. and Foster G. (2006). Cost Accounting: A Management Emphasis, New Jersey: Pearson Prentice Hall.
Gopinathan, T (2009) Profitability Ratios Measure Margins and Return (On-line):www.allspreadsheets.com Retrieved on 20th August, 2012).
Majdy, Z., Rafat, S., and Salah, A. (2011). Participation in Performance Measurement Systems and Level of Satisfaction. International Journal of Business and Social Science,Vol. 2, No. 8 Pp. 159-169.
Kanodia, C. (1993). Participative budgets as coordination and motivational devices. Journal of Accounting Research, 31(2):172“189.
Lambert, R. A. (1986). Executive effort and selection of risky projects. Rand Journal of Economics, 17(1):77“88.
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