CHAPTERONE INTRODUCTION1.1Background to the StudyBeyond
crunching and depicting numbers in the financial statements, the
primordial goal of financial management is creating wealth (Tugas,
2012). Wealth creation and general performance of any organisation
are measured in terms of its financial strength and weakness using
financial ratio (Shirkouhi, et al, 2012). Wealth creation is best
achieved by maximizing firms value through optimal usage of
resources over a long period of time (Tugas, 2012). In other words,
it is the continuous and sustainable accumulation of more assets
(growth) as time passes by. Putting these into perspective, wealth
creation is a factor of a series of sound business decisions, made
one after the other, that originate from structured or scientific
basis. As risks are the ones that prevent any firm from achieving
its objectives, coming up with structured and scientific bases of
decisions reduces the likelihood of the former (risks). In
financial management, one of these structured and scientific bases
on which firm decisions are anchored is the financial statement
analysis (Tugas, 2012).According to Drake (2010), financial
statement analysis is the selection, evaluation, and interpretation
of financial data, along with other pertinent information, to
assist in investment and financial decision-making. Moreover, it is
also the process of identifying financial strengths and weaknesses
of the firm by properly establishing relationship between the items
of the balance sheet and the profit and loss account (accounting
for management website). One of the tools in financial statement
analysis is financial ratio analysis. As financial statements are
usually lengthy, it will be more efficient and strategic to just
pick up the figures that matter and plug them in pre-defined
formulas developed through time by finance and accounting scholars.
Financial ratios provide insight into the strengths and weaknesses
of a business and give the managers indications of areas that need
improvement (Heidari, 2012).A thorough knowledge of which ratios to
be used and how to use them is a critical management skill. The
primary focus of every business is to make a profit, have enough
liquidity to pay its bills and maintain control of borrowed funds
(Heidari, 2012). Several ratios give managers the tools to evaluate
these areas and measure their performance. Businesses should
constantly monitor these ratios to detect negative trends and
identify areas that need improvement. Thus financial ratio
information assists its financial statement users in obtaining the
relevant information concerning the detail and source of cash for
operating, investing and financing activities of the company over a
reported period. While most business owners focus on providing
exceptional products and services to their customers, they must
also pay attention to the performance and health of their company
(Heidari, 2012). This study is therefore concerned with the
analysis of financial ratios as a measure of performance of
commercial banks in Nigeria.1.2Statement of the ProblemProper
evaluation/measurement of a company performance for investors,
shareholders and lenders is of paramount importance to management
of all businesses in general. Performance evaluation using
financial ratios from the statement of cash flow (SCF) have gained
attention from academicians and industry practitioners
(DeFranco&Schmidgall, 1998; Schmidgall, Geller, &Ilvento,
1993) as cited in (Ryu& Jang, 2004). This is mainly due to the
ability of financial ratios provide supplementary information in
understanding the "real" operational status of a business.Despite
the fact that financial ratios are becoming increasingly important
yardstick for performance measurement, limited efforts have been
made to investigate the best set of ratios for measuring financial
performance of firms especially in emerging economies like Nigeria.
Thus, this study is a modest attempt aimed at filling the hitherto
existing gap in the literature by examining the performance of the
banks using profitability, liquidity and leverage ratios; and
ascertains whether profitability ratios are better measure of
performance of commercial banks as compared to liquidity and
leverage ratios.1.3Objectives of the StudyThe broad objective of
this study is to access which set of financial ratios are better
measure of firms performance. The specific objectives are: 1. To
evaluate the financial performance of commercial banks using
profitability, liquidity and leverage ratios.2. To ascertain
whether there is a significant difference in the performance of
commercial banks when measured usingprofitability ratios and
liquidity ratios.3. To ascertain whether there is a significant
difference in the performance of commercial banks when measured
using profitability ratios and leverage ratios.1.4 Research
QuestionsThe following research questions are designed to guide
this study:1. What is the financial performance of commercial banks
using profitability, liquidity and leverage ratios?2. Is there any
significant difference in the performance of commercial banks when
measured using profitability ratios and liquidity ratios?3. Isthere
any significant difference in the performance of commercial banks
when measured using profitability ratios and leverage ratios?1.5
Research HypothesesThe following hypotheses have been formulated to
guide this investigation. Ho1: There is no significant difference
in performance of commercial banks when measured using
Profitability ratios and liquidity ratios.Ho2: There is no
significant difference in performance of commercial banks when
measured using Profitability ratios and leverage
ratios.1.6Significance of the StudyThe significance of this study
cannot be over-emphasized as long as the information need of
various users of financial statement is concerned. This is because,
it is only through financial ratio evaluation that data reported in
the financial statement can be meaningfully interpreted and
gainfully applied in decision making.Shareholders as well as
prospective investors will be able to know the profit earning
ability of the bank and the efficiency at which resources of the
bank are being used. They will be able to know the ability of the
bank to pay dividend.Employees are interested in the profitability
of the firm in order to be able to bargain for higher wages as well
as ascertain the ability of the firm to continue operation, where
the profitability of the firm is on the decline or negative, the
employees will be afraid of facing massive retrenchment.The
solvency and liquidity of the firm are of peculiar importance to
the creditors and financial institutions. The more insolvent a firm
is, the higher the risk of failure associated with such
firm.Management will be able to know the overall performance of the
bank. They will be able to spot out the banks areas of strength and
weakness, evaluate the present financial policy of the firm and see
to what extend the financial obligation of the bank is being
achieved.Finally as an academic work, this study update existing
literature on the topic and inform the readers and scholars
generally on the use of financial ratios to get useful information
from financial statement. These same analyses identify the
financial strengths and weaknesses of a firm. This may be
accomplished either through a comparison of the firms ratios over a
period of time or through a comparison of the firms ratios with
their nearest competitors and with the industry average. With all
these, Scholar/Academia and researchers may find this work very
important as well as reference point. That is to say, this research
work will serve as a reserviour of knowledge for further
research.1.7 Scope of the StudyThis research work is set out
basically to evaluate the financial performance ofbanks, thus the
scope of this study covers money deposit banks with particular
emphasis toAccess Banks Plc, Sterling Bank Plc, Eco-Bank Plc, First
city monumental bank (FCMB). The scope of this study in relation to
time covers a period from 2009 to 2013.
CHAPTER TWOREVIEW OF RELATED LITERATURE2.1 IntroductionThis
chapter reveals relevant literature on financial ratios. The
chapter will specifically focus on the conceptual framework,
historical development of financial analysis, nature and purpose of
financial ratios analysis, relevance of financial ratios in
analysing financial statement, users of financial ratios, major
categories of financial ratios, criteria for functional analysis,
achievements and significance of ratios, weakness, limitations of
ratio analysis and review of empirical studies. 2.2Historical
Development of Financial AnalysisFinancial statements analysis
originated from United States of America (USA) in the second half
of the nineteen century. It was in conjunction with industrial
revolution with the emergence of two professional managers who were
concerned with two important aspects:
1. The credit analysis which emphasized the ability2. The
managerial ability which emphasized profitability measures.But the
credit analysis approach dominated the general development of ratio
analysis especially, in the early years and had gained an
undertaking pattern of how ratio analysis evolved. There were
empirical study by Aitman (1974) who had employed several financial
ratios to predict the corporate bankruptcy through the multi
discriminant out of the 20 several ratios examined by him; he
selected five (5) that did the best combined job in predicting
bankruptcy.Financial analysis can be undertaken by management of
the firms or parties outside the firm. Pandey noted further that
the nature of analysis will differ depending on the purpose of the
analyst. He further explained that the financial literature, a lot
of importance has been attached to financial ratios for assessing
the financial health of a firm.Ratios can be worked out because
between any items and that means there may be as many ratios as
there are number of items, which can be set against each other. But
under an assessment of financial ratio it is not the practice to
work out or to assess all the ratios, only required ratios
depending upon the purpose of the analysis will be assessed.
Besides it is worth to note that though financial ratios can be
assessed even from a single corporate, but then it will not be
helpful to know the general trend of a business in managements
liquidity and profitability. The purpose can be served If only
ratios are assessed from the series of companies only. Then the
ratio analysis will help to disclose in what manner the business
has been generally forgoing or otherwise under each and every item.
When this trend is known the future can be easily projected
assuming that other things are equal.2.3 Conceptual Framework2.3.1
Concept of Financial RatiosTo make rational decision towards
achieving the objectives of the firm, the financial manager need to
have certain analytical tools. One of such tools is financial ratio
analysis. The balance sheet shows the financial data from these
statements to enable users of financial gain insight with better
understanding of the financial statement.Financial analysis is the
process of identifying the financial strength and weakness of the
firm by properly establishing the relationship between the items of
the balance sheet and the profit and loss accounts.According to
Ibiayo, (2004) defines financial ratio analysis as a technical part
of credit analysis used in making decision that has to do with
concrete method of analysis of financial statement. Financial
ratios relate balance sheet account to one another and also relate
income statement.Igben, (1999) defines ratios as a proportion or
fraction or percentage which expresses the relationship between one
items in a set of financial statement.Jack endoff (1962) in his
article: a study of published industry financial operating ratio
found that financial ratio consistently and clearly distinguished
between profitable and unprofitable firms I a period of 1945 55.
The current ratio, the working capital to total assets, and net
worth to total debt ratio of profitable firms were consistently
higher. But the relationship of the total assets to turn over
appeared to be inversed to the size of the firm.Jenning, (1999)
defines ratios simply as one express in terms of another number to
show the relationship between the numbers. It affords a means of
comparing figures prepared on different basis. Financial ratio is
an analytical used to evaluate performance and access credit
risk.Needless, et al (1999) defined financial ratio analysis as an
importance way of stating meaningful relationship between the
components of financial statements. The interpretation of ratio
must include a study of the underlying data. Ratios are guide or
shortcuts that are in evaluating a companys financial position and
operations and making comparisons with result in previous years or
with other companies. They identified purpose of ratio to include
pointing out areas needing further investigation.Pandey (2005)
defined financial ratio analysis as the process of identifying the
financial strength and weakness of the firm by properly
establishing relationship between the items of balance sheet and
the profit and loss account.2.3.2 Nature and Purpose of Financial
Ratios AnalysisRatio as a powerful tool of financial analysis is
defined according Pandey (2005), as indicated questioned of two
mathematical expressions and as the relationship between two or
more things. Ratio is used as a bench mark for evaluating the
financial position and performance of firm it help to summarise in
large quantities of financial data to make to quantitative
judgement about the firms financial performance.Therefore Leopold
and Joans, (1997) regarded financial ratio to be basically used for
two purposes.1. For assessing the performance of as a particular
company over a period of time.2. For comparing the performance of a
company at the same point in time.Other purposes of financial
ratios according to Adeniyi (2004) are 1. It indicates the
operating efficiency with which the firm is utilising its assets to
generate sales revenue.2. It indicates the extent to which the firm
has used its long term solvency by borrowing funds.3. It indicates
the ability of the firm to meet its current obligations.4. It
indicates the efficiency and performance of the firm.2.3.3
Relevance of Financial Ratios in Analyzing Financial Statement.Bit
information standing alone is meaningless an item can be judged
only by comparison with one or other times relatively with good
understanding of their differences. Analysis can help make
financial data more useful to particular types of statement users.
Thus the purpose of financial statement analysis is to tailor
information to the needs of the users.The absolute accounting
figures reported in the financial statement do not provide a
meaningful understanding of the performance and financial position
of a particular firm. For instance, a net profit figure as related
to the companys portfolio investment. This relationship between two
accounting figures is mathematically known as financial ratios.
Therefore, financial ratios help size up a company as trends and
relative to others (Pandey, 1999).Financial ratios contribute more
to the financial analyst to make quantitative judgement about the
companys financial performance and position (Pandey 2005).
2.3.4 Users of Financial RatiosFinancial ratios can be
undertaken by management of the firm or by parties outside the
firm, Viz; owners, creditors, Investors and others. The nature of
analysis will differ depending on the purpose of the
analyst.Adeniyi (2004) recognized the following users and their
specific needs since financial statement of an enterprise are used
by many categories of people who have contact with the business:1.
Management: They are concerned with the internal control
profitability of company and efficiency of management of assets,
they are interested in all aspects of financial ratio analysis that
outside investors used to evaluating the firm to bargain
effectively for more funds2. Shareholders: They are interested in
the ability of the business to pay interest and repay the principal
sum on a due date3. Creditors (Long-term and short-term): They are
interested in the ability of the business to also pay interest and
report principal sum on a due date, short-term creditors for
instance evaluate the firm liquidity position.4. Government:
Government is interested in the business profit to assess tax
liabilities and may also be interested in other information e.g.
statistics on the employment and wage level5. Customers: They are
interested in the ability of the company to maintain supplies6.
Employees: They are interested in a long-term stability of the
company on which their job depends and on the companys ability to
meet wage demands.7. Financial analyst and Advisers: They are
interested in advising their audience and that can be any of the
other interested groups for instance, stock-holders are interested
in the information on profitability and prospects of capital growth
to advice investors and potentials investors.8. Competitors: They
are interested in corporative performance of a business.2.4. Types
of Accounting RatioFinancial ratio analysis is a tool for
interpreting financial statements. It can provide an insight into
two important areas of management; the return on investment earned
and the soundness of the firms financial position. This technique
of analysis compares certain related items in the financial
statement to each others in a meaningful manner. The accounting
ratios may be classifies into the following:1. Liquidity Ratios2.
Leverage Ratios3. Activity Ratios4. Profitability Ratios.2.4.1.
LIQUIDITY RATIOS.Liquidity ratios measure the firms ability to meet
its current obligation. According to Chordia et al (2005),
Liquidity is the capability of a firm to sell assets at a sound
price to meet its short term financial debts. Liquidity ratios
verified that a particular firm has sufficient resources to meet
its current liabilities which are payable within a year. It is
extremely essential for a firm to be able to meet its current
financial obligation as they become due. In fact, the analysis of
liquidity needs the preparation of cash budgets and cash flow
statements, but liquidity ratios by establishing a relationship
between cash and other current assets to current
obligationsprovides a quick measure of liquidity.Pandey (2004:503)
state that the liquidity ratios which indicate the extent of
liquidity or lack of it are:i. Current Ratioii. Quick Ratio (Acid
Test Ratio)iii. Cash Ratioiv. Working Capital Ratio.CURRENT RATIO:
This ratio compares total assets with total liabilities. According
to Fraser &Ormiston (2004), current ratio is the ability of a
company to meet its debts requirements as they become payable. The
rationale behind this is to determine the extent to which all
liquid and marketable securities (cash, stock, debtors and
inventories as well as prepayment) would suffice to defray all
short-term liabilities (creditors, bank overdraft, dividends
payable and current taxation). If all these become due at the same
time, this ratio is an important measure of potential liquidity,
although the assumption that all current assets can be realized on
the same day is a major weakness. The current ratio is a measure of
the firms short-term solvency. A ratio if greater than one has more
current assets than current liabilities or claims against them. As
a conventional rule, a current ratio of 2:1 or more is considered
satisfactory.Current Ratio=Current Assets Current LiabilitiesThe
current ratio represents a margin of safety, i.e a cushionof
protection of creditor, the higher the current ratio, the greater
the margin of safety, the higher the amount of current assets in
relation to current liabilities, the more the firms ability to meet
its current obligation. Current assets can decline in value but
current liabilities cannot decline in value. If the firms current
assets consist of doubtful debts and showing unstable stock of
goods, then the firms ability to pay back is inspired. Its short
term solvency is threatened. Thus, too much reliance should not
place on the current ratio, further investigation about the
quantity of current assets should be carried-out, and however the
current ratio is a crude and quick measure of the term
liquidity.QUICK RATIO (ACID TEST RATIO): This is a more refined
measure of liquidity of a firm. The ratio establishes a
relationship between quick or liquid assets and current
liabilities. According to Horngren et al (1999), Quick or acid test
ratio is the ability of a company to meet its current liabilities
as they come due immediately. Quick ratio eliminates the
liquidation of inventories from the numerator, measured the least
liquid current assets. The quick ratio is thus found by dividing
the total of the quick assets by the total current
liabilities.Quick Ratio=Total Quick or Liquid AssetsTotal Current
LiabilitiesQuick assets include cash and debts (debtors and bills
receivables). Inventories are excluded because it takes time to
sell finished goods and convert raw materials and work-in-progress
into finished goods. Also, there is uncertainty as to whether or
not the inventories can be sold. Prepaid expenses should also be
excluded because they cannot be converted into cash.Generally, a
quick ratio of 1:1 is considered to represent a satisfactory
current financial condition. Although the quick ratio is a more
penetrating test of liquidity than the current ratio, yet it should
be used with cautious. A quick ratio 1:1 or more does not
necessarily imply sound liquidity position. It should be remembered
that all bad debts may not be liquid and cash may be immediately
needed to pay operating expenses.It should also be noted that the
liquidity ratios are subject to the influences of other financial
forces which can improve or deteriorate the ratios in no time. The
ratios fluctuate not only because of the movement of receivables
and inventories, but are also affected by changes in fixed assets,
investment, sales and profit or loss.CASH RATIO: Since cash is the
most liquid asset, a financial analyst may examine this ratio.
However, some authors use the word liquidity ratio for cash ratio
since trade investment or marketable securities are equivalent of
cash. Therefore, they may be included in the computation of cash
ratio which is cash plus marketable securities divide by cash
liabilities. Cash ratio is calculated thus; cash plus marketable
securities divide by cash liabilities. Cash Ratio=Cash + Marketable
SecuritiesCash Liabilities.WORKING CAPITAL RATIO: The working
capital ratio is a liquidity ratio that measures a firms ability to
pay off its current liabilities with current assets. The working
capital ratio is important to creditors because it shows the
liquidity in the company. Current liabilities are best paid with
current assets like cash, cash equivalents, and marketable
securities because these assets can be converted into cash much
quicker than fixed assets. The faster the assets can be converted
into cash, the more likely the company will have the cash in time
to pay its debts (www.myaccountingcourse.com).The reason this ratio
is called the working capital ratio comes from the working capital
calculation.When current assets exceed current liabilities, the
firm has enough capital to run its day-to-day operations. In other
words, it has even capital to work. The working capital ratio
transforms the working capital calculation into a comparison
between current assets and current liabilities. The working capital
ratio is calculated by dividing current assets by current
liabilities. Working Capital Ratio=Current AssetsCurrent
LiabilitiesThis calculation makes the firm to understanding what
percentage a firms current assets are to its current
liabilities.
2.4.2 Leverage Ratios.These ratios can be called long-term
solvency ratios. Business organization derives a measure of
advantage from this by borrowing on medium and long-term basis in
order to finance part of their operations. Such advantages which of
this form enhanceearning per share if the return on assets exceeds
the cost of servicing the loan and this often referred to as
leverage effect. According to Sharma (2012), Leverage ratios
involve the obligations a company holds along with the shareholders
equity. It is used to show the firms ability to meet its financial
obligations.Short-term creditors like bankers, suppliers of raw
materials are more concerned with the firms current debt paying
ability. On the other hand, long-term creditors like financial
institutions, debenture holdersetc are more concerned with the
firms long-term financial strength. In fact, a firm should have a
strong short-term as well as long-term financial position. In order
to judge the long-term financial position of a firm, financial
leverage or capital structure ratio are calculated. Thus, leverage
ratio is calculated to measure the financial risk and the firms
ability of using debt for the benefit of its shareholders. The
principal leverage ratios are as follows:i. Debt to Assets Ratioii.
Debt to Equity Ratioiii. Debt to Total Capitalisation Ratioiv.
Time-Interest-Earning RatioDEBT TO ASSETS RATIO: The ratio of debt
to total assets, generally called the debt ratio measures the
percentage of total funds provided by creditors. According to
Brigham & Houston (2009), the ratio of total debt to total
assets measures the percentage of funds provided by creditors. This
debt includes both current liabilities and all bonds. Creditors
prefer low debt ratios this is because the lower the ratio, the
greater the caution against creditors losses in the event of
liquidation, in contrast to the creditors preferences for a low
debt ratio, the owners may seek high leverage ratio in order to
either;a) Magnify earnings orb) Because of selling new stock means
giving up degree of control. Therefore, debt ratio is calculated
thus:
Debt Ratio = Total DebtTotal Assets orDebt Ratio = Total
Liabilities Total Assets.DEBT TO EQUITY RATIO: This ratio includes
the relationship between long-term funds provided by creditors and
those provided by the firms owners. Fraser &Ormiston (2004)
noted that the debt to equity ratio measures the riskiness of the
companys capital structure in terms of the relationship between the
funds supplied by creditors and investors. It is commonly used to
measure the degree of financial leverage of the firm. It is
calculated by dividing long-term debt by stakeholders
equity.Debt-Equity Ratio = Long-term DebtStakeholders Equity.Firms
with large amount of fixed assets and stable cash flow typically
have high debt- equity ratios; while other less capital intensive
firms normally have lower debt-equity ratios.DEBT TO TOTAL
CAPITALISATION RATIO: This measures the percentage of the firms
long-term funds supplied by its creditors. The firms long-term
funds are referred to as its total capitalization. They include
both long-term debt and the shareholders equity. The ratio of debt
to total capitalization can be calculated by dividing long-term
debt by total capitalization.
Debt-Total CapitalisationRatio =Long-term DebtTotal
CapitalisationSince there is great similarity between the debt to
equity ratio and debt to total capitalization ratio, an analyst
needs only one of these two for analysis, the resulting value is
meaningful only in the light of the nature of the firm's operations
and industry averages.TIME-INTEREST-EARNED RATIO: The times
interest earned ratio, sometimes called the interest coverage
ratio, is a coverage ratio that measures the proportionate amount
of income that can be used to cover interest expenses in the
future. In some respects the times interest ratios is considered a
solvency ratio because it measures a firms ability to make interest
and debt service payments. The times interest earned ratio is
calculated by dividing income before interest and income taxes
divided by the interest expenses.TimeInterest to earned ratio =
Income before Interest + Income taxesInterest expensesSince this
interest payment is usually made on a long term basis, they are
often treated as an ongoing fixed expense.As with most fixed
expense, if the company cant make the payments, it could go
bankrupt and cease to exist.Thus, this ratio could be considered a
solvency ratio (investopedia.com).2.4.3 Activity RatioActivity or
turnover ratio represents the firms ability to obtain the highest
income by using its resources correctly (Hussianet al 2013).It is
an accounting ratio that measures a firms ability to convert
different account within its balance sheets into cash or sales.
Activity ratio are used to measure the relative efficiency of a
firm based on its use of its assets, leverage or other such balance
sheet items.These ratios are important in determining whether a
companys management is doing a good enough job of generating
revenues, cash etc. from its resources.Companies will typically try
to turn their production into cash or sales as fast as possible
because this will generally lead to higher revenues.Such ratios are
frequently used when performing fundamental analysis on different
companies.Baruch(1974) said that, incalculating turnover ratio
sales revenue remains as the numerator whereas assets, account
receivables, inventory etc are used as the denominator. The
commonly used turnover ratios are as follows:i. Accounts Receivable
Turnoverii. Accounts Payable Turnoveriii. Fixed Assets Turnoveriv.
Inventory Turnoverv. Total Assets Turnover. ACCOUNT RECEIVABLE
TURNOVER:This is an efficiency ratio or activity ratio that
measures how many times a business can turn its account receivable
into cash during a period. According to Fraser and Ormiston (2004),
the accounts receivable turnover ratio measures how many times, an
average accounts receivable are collected in cash during the year.
This ratio shows how efficient a company is at collecting its
credit sale from customers. Some companies collect their receivable
from customers in 90days while others take up to 6 months to
collect from customers.In some ways the receivables turnover ratio
can be viewed as a liquidity ratio as well. Companies are liquid
the faster they can convert their receivables into cash. Accounts
receivable turnover is calculated by dividing net credit sales by
the average accounts receivable for that period.Account Receivable
Turnover = Net credit sales Average account receivableSince the
receivables turnover ratio measures a firms ability to efficiently
collect its receivables, it only makes sense that a higher ratio
would be more favourable. Higher ratio means that companies are
collecting their receivables more frequently throughout the year.
Accounts receivable turnover is also an indication of the quality
of credit sales and receivables. A company with a higher ratio
shows that credit sales are more likely to be collected than a
company with a lower ratio. Account receivable turnover is very
important because it is often posted as collateral for collecting
loans.ACCOUNT PAYABLE TURNOVER:The accounts payable ratio is a
liability ratio that shows a companys ability to pay off its
accounts payable by comparing net credit purchases to the average
accounts payable during a period. According to Fraser &Ormiston
(2004), the accounts payable turnover ratio measures how many times
on average, accounts payable are paid during the year. In other
words, the accounts payable turnover ratio is how many times a
company can pay off its average accounts payable balance during the
course of a year. This ratio helps creditors analyzed the liquidity
of a company by gauging how easily a company can pay off its
current suppliers and vendors. Companies that can pay off supplies
frequently throughout the year indicate to creditor that they will
be able to make regular interest and principal payments as well.
The accounts payable turnover ratio is calculated by dividing the
total purchases by the average accounts payable for the
year.Accounts Payable Turnover =Total PurchasesAverage Accounts
PayableSince the accounts payable turnover ratio indicates how
quickly a company pays off its vendors, it is used by suppliers and
creditors to help decide whether or not to grant credit to a
business. As with most liquidity ratio, a higher ratio is almost
always more favorable than a lower ratio; a higher ratio shows
suppliers and creditors that the company pays its bills frequently
and regularly. It also implies that new vendors will get paid
quickly.A high turnover ratio can be used to negotiate favorable
credit terms in the future. As with all ratios, the accounts
payable turnover is specific to different industries. That is, it
is best used to compare similar companies in the same
industry.FIXED ASSET TURNOVER: According to Powell (2005), fixed
asset turnover is the ratio of sales (on the profit and loss
account). It indicates how well the business is using its fixed
assets to generate sales. Fixed asset turnover ratio is an Activity
ratio that measures how successfully a company is utilizing its
fixed assets in generating revenue. A higher fixed asset turnover
ratio is generally better. However, there might be situations when
a high fixed asset turnover ratio might not necessarily mean
efficient use of fixed assets. Fixed asset turnover is calculated
by dividing the net revenue by average fixed assets.Fixed Assets
Turnover = Net Revenue Average Fixed AssetsAccording to Fraser
&Ormiston (2004), fixed assets turnover is extremely important
for a capital intensive company and considers only the companys
investmentin fixed assets. In other words, the higher the ratio the
better,because a high ratio indicate that the business has less
money tied up in fixed assets for each unit of currency of sales
revenue. A declined ratio may indicate that the business is
over-invested in plant, equipment, or other fixed assets. INVENTORY
TURNOVER: The inventory turnover ratio is an efficiency ratio that
shows how effectively inventory is managed by comparing cost of
goods sold with average inventory for the period. Sharma (2012)
studied that inventory turnover ratio is employed to represent the
number of times inventory is sold or used in the company during the
financial era. It also measures how many times average inventory is
turned or sold during a period. This ratio is important because
turnover depends on two main components of performance. The first
component is stock purchasing; if larger amount of inventory are
purchased during the year, the company will have to sell greater
amount of inventory to improve its turnover. The second component
is sales; sales have to match inventory purchases otherwise the
inventory will not turn effectively. The inventory turnover ratio
is calculated by dividing the cost of goods sold for a period by
the average inventory for that period.Inventory turnover = Cost of
Goods Sold Average Inventory.Since inventory turnover is a measure
of how efficiently a company can control its merchandise, it is
important to have a high turn. This shows the company does not over
spend by buying too much inventory and waste resources by storing
nonsalable inventory. It also shows that the company can
effectively sell the inventory it buys.This measurement also shows
investors how liquid a companys inventory is; that is, how easily a
company can turn its inventory into cash. TOTAL ASSETS TURNOVER:The
total assets turnover ratio measures the ability of a company to
use its assets to efficiently generate sales. It measures the
efficiency of managing all of a companys assets (Fraser
&Ormiston 2004). This ratio considers all assets, current and
fixed. These fixed assets include plant and equipment, inventory,
accounts receivable etc as well as other current assets. The total
asset turnover ratio calculates net sales as a percentage of assets
to show how many sales are generated from each unit of company
assets, and it is calculated by dividing net sales by average total
assets.Total Assets Turnover = Net Sales Average Total Assets.Since
ratio measures how efficiently a firm uses its assets to generate
sales, so a higher ratio is always more favourable. Higher turnover
ratios mean the company is using its assets more efficiently. Lower
ratios mean that the company is not using its assets efficiently
and most likely have management or production problems. The total
asset turnover ratio is also a general efficiency ratio that
measures how efficiently a company uses all of its assets. This
gives investors and creditors an idea of how a company is managed
and uses its assets to produce products and sales.2.4.4
Profitability RatioA profitability ratio is a measure of profit
which is way to measure a companys performance. It is the capacity
to make profit, and profit is what is left over from income earned
after deducting all costs and expenses related to earning of the
income. In general, profitability ratios measure the efficiency
with which a firm turns business activity into profits. According
to Hussain et al (2013), profitability ratios indicate the overall
efficiency and performance of firm. Some of the major profitability
ratios are as follows:i. Gross profit marginii. Net profit
marginiii. Return on Assetsiv. Return on Equity v. Earning Power
Ratio.GROSS PROFIT MARGIN: Gross profit margin is a financial
metric used to assess a firms financial health by revealing the
proportion of money left over from revenues after accounting for
the cost of goods sold. It is used as an indicator of a businesss
financial health. It shows how efficiently a business is using its
material and labour in the production process and gives an
indication of the pricing, cost structure, and production
efficiency of the business. Gross profit margin serves as the
source for paying additional expenses and future savings. It is
calculated as gross profit divide by total revenue.Gross Profit
Margin = Gross Profit Total Revenue.Gross profit margin shows the
total increase between cost of goods sold and sales revenue. It
also reflects the efficiency with which the management produces
each unit of product (Brealey& Myers 1984).NET PROFIT MARGIN:
Net profit margin is the percentage of revenue remaining after all
operating expenses, interest, taxes and preferred stock dividends
have been deducted from a companys total revenue. Net profit margin
signifies the overall measure of a companys ability to turn each
unit of sales into net profit. It also establishes relationship
between sales and net profit. It indicates managements efficiency
in administrating, manufacturing and selling the products
(Brealey& Myers 1984). Net profit margin is calculated by
dividing net profit by total revenue.Net Profit Margin = Net Profit
Total RevenueThis is often used to compare companies within the
same industry, in a process known as margin analysis. Net profit
margin is a percentage of sales, not an absolute number, so it can
be extremely useful to compare net profit margins among a group of
companies to see which are most effective at converting sales into
profit (investinganswers.com).RETURN ON ASSET: Return on assets is
the ratio of annual net income to average total assets of a
business during a financial year. It measures efficiency of the
business in using its assets to generate net income. According to
Sharma (2012), return on assets ratio shows how competently total
assets has been utilized by the company. It also indicates the
overall rate of return on total assets of the firm. To determine
return on total assets, net income is compared with total assets of
the company. It is calculate as annual net income divide by average
total assets.Return on Asset = Annual Net IncomeAverage Total
AssetsReturn on assets indicates the number of percent earned on
each value of assets. Thus higher values of return on assets show
that business is more profitable. This ratio is only used to
compare companies in the same industry
(accountingexplained.com).RETURN ON EQUITY: Return on equity is the
amount of net income returned as a percentage of shareholders
equity. According to Hussain et al (2013), return on equity ratio
demonstrates how efficiently firms utilize common stockholders
equity in company. It measures a corporations profitability by
revealing how much profit a company generates with the money
shareholders have invested. Return on equity is expressed as a
percentage and is calculated as annual net income divide by average
stockholders equity.Return on Equity = Annual Net Income Average
stockholders EquityReturn on equity is an important measure of the
profitability of a company. Higher values are generally favourable
meaning that the company is efficient in generating income on new
investment. Investors should compare the return on equity of
different companies and also check the trend in return on equity
over time (accountingexplained.com).EARNING POWER RATIO: Earning
power ratio is measure that calculate the earning power of a
business before the effect of thebusiness income taxes and its
financial leverage. It indicates the raw earning power of the
companys assets before the pressure of taxes and debts (Hussain et
al 2013). It is calculated by dividing earnings before interest and
taxes (EBIT) by total assets (Brigham & Houston 2009).Earning
Power Ratio = EBIT Total AssetsEarning power ratio is similar to
return on assets as both have the same denominator which is total
assets. 2.5Objectives of Financial Ratio AnalysisBefore starting
the analysis of any firms financial statements, it is necessary to
specify the objectives of the analysis. According to Fraser and
Ormiston (2004), the objectives will vary depending on the
perspective of the financial statement user and the specific
questions that are addressed by the analysis of the financial
statement data.Among the several perspectives is that of the
creditor, the investor, and the management. Each of these
stakeholders would have to have questions that need to be answered.
For instance, a creditor is usually concerned with the ability of
an existing or prospective borrower to make interest and principal
payments on borrowed funds. The investor usually attempts to arrive
at an estimation of a companys future earnings stream in order to
attach a value to the securities being considered for purchase or
liquidation. Lastly, financial statement analysis from the
standpoint of management relates to all of the questions raised by
creditors and investors because these user groups must be satisfied
in order for the firm to obtain capital as needed.According to
Brigham and Houston (2009), financial analysis involves comparing
the firms performance to that of other firms in the same industry
and evaluating trends in the firms financial position over time.
One rich source of information for financial statement analysis is
the audited financial statements. The financial statements are
usually part of the annual report that listed companies submit to
regulatory agencies such as Securities and Exchange Commission and
Stock Exchange entities.Ratio analysis as a basis of appraising
financial performance uses financial reports, data and summaries of
key relationships such as profit of sales, earnings per share,
dividends yield, net profit margin and many other ratios that are
important to the analysis (Omoregie et al 2014). Reliance on
certain ratio depends on the analysis perception of their
predictive power relating to the problem at hand, a perception
based on either subjective belief or empirical analysis. Randle
(1991) suggests that in predicting the future value of a stock, an
investor might feel that the return on investment ratio and profit
margin ratio would be the greatest help.Financial ratios to predict
corporate bond rate; with these ratios as the dependent variables,
regression analysis and discriminate analysis have been employed,
using various financial ratios for a sample companies. The best
ratios for predictive purpose are debt to equity, cash flow to
debt, net operating profit margin, debt average and its stability
(Omoregie et al 2014). On the basis of these, it appears that a
handful of ratio can be used to predict the long-term credit
standing of a firm.According to Sangster (1996), a financial
analyst will want to estimate a securitys future sensitivity to
major factors and unique risk because the information is to
determine the risk of investment. Perhaps the analyst will also
want to estimate the dividend yield of a security over the next
year in order to determine its suitability for investors in which
dividend yield is relevant. Careful analysis of such matters as a
companys dividend policy and likely future cash flow may lead to
better estimates that can be obtained by extrapolating last years
dividend yield. In many cases, it is desirable to know something
about the source of a securitys risk on return.2.6Significance of
Ratios The ratio analysis is the most powerful tool of the
financial analysis. As stated earlier in this study, many diverse
groups of people are interested in analyzing the financial
information to indicate the operating and financial efficiency and
growth of the firm. These people use ratio to determine those
financial characteristics of the firms in which they are
interested. A wise and prudent investor takes into consideration;
however that can sustain his interest to invest in a company or to
remain through the retention of his shares (Collins and Johnson,
1999) some of these factors are:(i) Security(ii) Liquidity(iii)
Returns(iv) Spread risks(v) Growth prospectsThere is a connection
between profitability, liquidity and solvency. Poor profitability
leads to illiquidity. Illiquidity leads to bankruptcy or
insolvency. Insolvency leads to liquidation. Profitability
companies can become illiquid without good cash management.
Profitability, liquidity and solvency problems can be curved with
vigilant financial management and strong strategic planning
(Collins and Johnson 1999). Here are the achievement and
significance of ratios as enumerated by (Collins and Johnson,
1999).2.7Weakness and Limitations of Ratio Analysis Ratio analysis
is a widely used technique to evaluate the financial position and
performance of a business. But there are certain problems in using
ratio. Argent (1977) has drawn attempt three limitations of
financial ratio analysis which restricts the usefulness of
financial ratio for predicting business failure in the following
terms.(i) The ability of ratio alone to predict corporate collapse
has not been conclusively proves.(ii) Their value may have been
eroded by inflation figure that appear to show an improvement out
may actually conceal deterioration in real terms.(iii) Managers
start creative accounting when they perceive or know that things
are wrong thus in hiding the fell-face symptoms. Creative
accounting involves making the companys result look better than
there are for example, by cutting expenditure on routine
maintenance. This phenomenon explains why so many people do not
appreciate the serious difficulties of suspect companies until the
day the solvency is announced.Patron and Paton (1964) added ratios
are not a satisfactory substitute for judgment their calculation is
nothing more than a means of focusing attention on relationship
that are worth of careful observation and study. They are therefore
dues and not basis for immediate conclusion.Olowe (1997) conclude
the ratio calculate at a point of time are less informative and
defective as they suffer short-term changes. Thus, they are of
little value in predicting future result. The limitations of ratio
include the following:1. It may be difficult to obtain a suitable
yardstick for comparison where a company operates a number of
different division in different industries establishing a standard
of comparison in a difficult task.2. The number of various ratios
is so large i.e. that is a very difficult task to select some
appropriate ratios for various business units.3. In carry out trend
analysis, the analysis could be affected by:a. Changes in the
nature of business from one accounting period to the other.b.
Changes in accounting policies from one period to the other.c.
Changes in government incentive package.4. The various formulae for
working out ratios have also been taken as standard formulae.
Ratios are work out on the basis of different items and different
industries.5. When undertaking cross sectional analysis identifying
companies that are comparable for the following reasons may be
difficult.a. The companies may have different accounting policiesb.
To companies may have different degree of diversification6. In
general, it is incorrect to compare small firm with large firm,
many of the general industrial analysis of ratios are overall
average and therefore not strictly comparable to any particular
firm.The above weakness and limitations are not all that
withstanding to outrun the significance of ratio analysis as that
cannot be ruled out in any form whatsoever.2.8Performance
Evaluation Using Financial RatiosThe performance evaluation is
considered as the final step in a series of the administrative
process where the administrative process starts by identifying the
desired objectives as a result of administrative unit, and then a
plan is prepared to achieve these objectives followed by the
controlprocess over the implementation in order to identify the
deviations of the actual results of what the plan and the
objectives identifies as expected results and the control process
leads the evaluation process (Abdel &Dalabeeh).According to
Keith (1987), performance evaluation always exist and always has in
any group, a persons performance tends to be judged in some way by
others, appraisal is necessary in order to allocate resources in a
dynamic environment, reward employees, give feedback, maintain
fairness, coach and develop employees towards attainment of goals.
The process of evaluation is the most difficult administrative
tasks because it includes many different variables, some are
descriptive and others are personal and because of this, it seems
difficult to measure the performance (Abdel &Dalabeeh 2013:13).
But having standards for evaluating the performance means the
availability of a physical measurement could be applied for the
individuals.According to Kahala&Hanan (1998), evaluating the
performance is one of the systematic control steps of the costs and
these costs include the following:i. Preparing the Approach: this
step I done at the level of planning.ii. The Control: this step
starts at the beginning of the implementation level and continue
till the actual implementation level is over.iii. The Judgment: to
evaluate the performance and identify the level of the efficient
productivity.iv. The Treatment: writing a report of the urgent
deviations and their causes to decisions as a treatment for
them.2.9Review of Empirical Studies Enekwe, Okwo and Ordu; (2013)
investigated financial Ratio analysis as a determinant of
profitability in Nigerian pharmaceutical industry. The study
incorporated variables such as Inventory Turnover Ratio (ITR),
Debtors Turnover Ratio (DTR), Creditors Velocity (CRSV), Total
Asset Turnover (TAT) and Gross Profit Margin (GPM) to analyze the
financial statements of the selected companies. Findings revealed
that financial ratios have a negative relationship with the
profitability of companies.Boune and Neely; (2003) examined
implementing performance measurement system: a literature review
the paper reviews the different performance measurement system;
design processes published in the literature and create a framework
for comparing alternative approach. He concludes that performance
measurement literature was at the stage of identifying difficulties
and pitfalls to be avoided based on practitioner experience with
few published studies.Mais; (2005) studied the effect of financial
ratios such as Net Profit Margin (NPM), Return on Assets (ROA),
Return on Equity (ROE), Dividend Earned Ratio (D/E) and Earning per
Share (EPS) on stock price of companies listed on Jakarta Islamic
Index. The outcome of this research explains that statistically all
variables except Dividend Earned Ratio are significant and have
positive impact on stock price.In Indonesia, Daniati and Suhairi,
(2006) studied the use of accounting information for predicting
returns. His findings revealed that cash flow from investing
activities, gross profit and company size significantly affect
expected return on shares, on the other hand, cash flow from
operating activities does not affect expected return significantly.
Meythi, (2006) studied 100 manufacturing firms in BEJ during
1999-2002 and conclude that, with profit persistence as intervening
variable, cash flow from activities does not affect stock
price.Kennedy; (2005), Analyzed the effect of ROA, ROE, EPS, Profit
Margin, Assets Turnover, DTA and DER on stock return using sample
of stocks from LQ 45 index in BEJ during the period 2001-2002. This
research find out that TATO, ROA, EPS, and DER have positive
effect, while ROE and Debtors Turnover have negative effect on
stock return, however all variables statistically insignificant in
influencing stock return.Rosewati; (2007), studied the effect of
CR, TATO, DER, ROE, EPS and PBV on stock price of manufacturing
industry with five sub-industries including retail, food and
beverages, tobacco, automotive and pharmacy, the result shows that,
the significant financial ratios in retail industry are ROE, EPS,
and PBV, in food and beverages are EPS and PBV, in tobacco industry
are CR, TATO, DER EPS, and financial ratios are TATO, DER, EPS and
PBV.Hamzah; (2003), Analyzed correlation between Financial Ratios,
including Liquidity Ratio (Current Ratio), Profitability Ratio
(Return On Investment), Activity Ratio (Total Asset Turnover) and
Solvability Ratio (Debt to Equity), and both capital gain (loss)
and dividend in 135 manufacturing companies listed on Jakarta stock
exchange. This research discovers that all ratios have positive
correlation with gain (loss). However only current ratio that was
statistically significant at 5%. Furthermore, the correlation with
dividend yield, only Total Asset Turnover that is proved
significant at 5%.Dwi, Malone and Rahfiani; (2009), studied the
effect of financial ratio, firm size and cash flow from operating
activities in the interim report to the stock return using 39
manufacturing companies listed on Indonesia Stock Market. The
result shows that profitability, Turnover and Market ratio has
significant impact to the stock turnover.
CHAPTER THREERESEARCH METHODOLOGY3.1 IntroductionThis chapter
examines the methodology that will be adopted in achieving the
studys stated objectives. The chapter therefore focuses on the
research design, the population of the study, the study sample and
the sampling techniques. The chapter also covers sources of data
collection, techniques of data analysis, definition of variables,
model specifications and the limitations of the study.3.2 Research
DesignThis study employs the descriptive and comparative research
approach of paired t-test in the investigation. The reason for the
study adopting the descriptive research design is due to its
ability to offer a snapshot of current situation or conditions.
Also, thecomparative research design method fits into this study
because the study searches for answers to some questions as to
whether profitability ratios are better measure of performance of
commercial banks as compare to leverage and liquidity ratios.
3.3Population of the StudyThe population of this study comprises
of all the 21commercial banks quoted on the Nigerian stock exchange
(NSE) as of December 2014.3.4Sample Size of the Study.This study
purposively selects four (4) money deposit banks namely Access
BanksPlc, Sterling Bank Plc, Eco-BankPlc, First city monumental
bank (FCMB) to constitute the sample size for the study. The choice
of these banks is due to the easy accessibility of annual published
reports for all the years under investigation.3.5 Sources of
DataThe main sources of data for this study are secondary data.
Secondary data in respect to variables under investigation were
sourced from the annual published accounts of the selected money
deposit banks from the year 2009-2013.3.6 Definition of Variables
Employed in the Study Profitability Ratios:A profitability ratio is
a measure of profit which is way to measure a companys performance.
It is the capacity to make profit, and profit is what is left over
from income earned after deducting all costs and expenses related
to earning of the income. In general, profitability ratios measure
the efficiency with which a firm turns business activity into
profits. Profitability used in this study includes: net profit
margin (NPM), Return on Assets (ROA) and return on equity
(ROE).Liquidity Ratios: Liquidity ratios measure the firms ability
to meet its current obligation. Liquidity ratio used in this study
includes: working capital (CA-CL) and net worth to total asset
(NW/TA).Leverage Ratios:These ratios can be called long-term
solvency ratios. Leverage ratios involve the obligations a company
holds along with the shareholders equity. It is used to show the
firms ability to meet its financial obligations. Leverage ratio
used in this study includes:Loan to total deposit (L/TD) and
capital adequacy ratio (CAR(SE/TD).3.7 Techniques of Data
AnalysisThis study is set to examine whether profitability ratios
are better measure of performance of money deposit banks as compare
to liquidity and leverage ratios. In order to achieve these
objectives, the study adopts majorly the use of descriptive
statistics to summarize the collected data in a clear and
understandable way using numerical approach.Furthermore, paired
sampled t-test was further adopted in the analysis of data. Data in
respect to profitability ratios, liquidity ratios and leverage
ratios was taken as a separate pair. Profitability ratios were
compared with liquidity and leverage ratios using the independent
paired sampled t-test. This was done with the aid of the
statistical package for social science (SPSS) version 20.Decision
ruleThis study establishes the following criteria to accept and
reject the research hypotheses. Accept the null hypothesis if the
critical value of t under 0.05 in the t-table is greater than the
calculated value. Reject the null hypothesis if the critical value
of t under 0.05 in the t- table is less than the calculated
value.
CHAPTER FOURDATA PRESENTATION, ANALYSIS AND INTERPRETATION OF
RESULTS4.1IntroductionThis study examines whether there is a
significant difference in the performance of commercial banks in
Nigeria when measured using profitability ratios and liquidity
ratios and profitability ratios and leverage ratios. In this
regard, this chapter therefore presents findings from data analysis
using the research methodology lucidly explained in chapter three.
Specifically, this chapter presents data and results of the paired
sample descriptive statistics analysis, paired sample correlation
and paired sampled t-test, testing of hypotheses and finally
discussion and interpretation of findings. Data analysis herein
will be done with the aid of the Statistical Package for Social
Sciences (SPSS version 20).4.2Data Presentation and AnalysisTable
4.1 (See Appendix 1) presents aggregate data extract of all
commercial banks in Nigeria from the period 2009-2013 in respect to
all the variables under examination. A five year average was taken
in respect to all the classes of ratios in order to observe the
trend in performance of each commercial bank using ratios. These
analyses are performed below: Profitability RatiosBanks Years 5
year Average ROA5 year Average ROE5 year Average OPM
ACCESS BANK PLC2009-20132.14%1.07%34.20%
STERLING BANK PLC2009-20131.72%19.36%21.03%
ECO-BANK PLC2009-20132.6620.06%34.28%
FCMB2009-20131.206.44%18.52%
Return on Assets (ROA)This is the ratio of Net profit to total
assets. It also indicates whether the total assets of the company
have been properly used or not. If not properly used, it proves
inefficiency on the part of the management. It also helps measure
the profitability of the firm.Return on Assets = Profitbefore
TaxTotal AssetsThe 5 year average performance of the banking
industry in Nigeria as far as the Return on Assets is concerned is
given onthe table above. The figures are then compared with the
individual performance of the four selected banks.Generally, all
the banks had a very poor average ROA over the five year period.
Again,there is not much difference between the performances of the
banks using ROA.A cursory look at the table revealed that Eco-bank
has the highest ROA of 2.66% while FCMB has the lowest ROA of
1.20%. This implies that during the period under study, Eco-Bank
recorded the highest profitability among the selected banks while
FCMB achieved the lowest profit.Return on Equity (ROE)This is
calculated by dividing the net profit after tax by the shareholders
equity. This ratio is applied for testing profitability. The higher
the ratio, the better is the return for the ordinary
shareholders.Return of Equity = Net IncomeShareholders EquityThe
table below shows the trend of average ROE in the Nigerian banking
industry from 2009-2013, this is then compared to those of the four
individual banks under review. The return on equity is generally
low for all the banks over the five year period. As usual, Eco-Bank
has the highest return on equity of 20.06%. That is, for every 1
naira of shareholders equity, the bank is able to generate a net
profit of 20.06%. This is quite low. Sterling bank and FCMB
followed with a five year average ROE of 19.36% and 6.44% while
Access bank has the least ROE of 1.07%. Net Profit MarginThis is
the ratio of net profit to net sale, and is also expressed as a
percentage. It indicates the amount of sales left for shareholders
after all costs and expenses have been met. It is the difference
between gross profit and operating and non-operating income minus
operating and non-operating expenses after deduction of tax. The
ratio measures the overall efficiency of the management.
Practically, it measures the firms overall profitability.If the
ratio is found to be too low, many problems may arise, dividend may
not be paid, operating expenses may not be paid etc. Moreover,
higher profit earning capacity protects a firm against many
financial hindrances such as adverse economic condition. The higher
the ratio, the greater will be profitability, and the higher the
return tothe shareholders. 5% to 10% may be considered normal.
Net Profit Margin = Net Profit (Before Tax)SalesThe table above
revealed that Eco-Bank has the highest net profit margin of 34.28%
followed by Access Bank and sterling bank with a NPM of 34.20% and
21.03% respectively while FCMB has the least NPM of 18.52.
Generally all the commercial bank in the industry could be adjudged
to have a poor net profit margin.Liquidity RatiosBanks Years 5 year
Average CR5 year Average NW/TA
ACCESS BANK PLC2009-20131.170.21
STERLING BANK PLC2009-20131.100.09
ECO-BANK PLC2009-20130.950.12
FCMB2009-20131.220.23
Current Liquidity RatioIt is the relationship between the amount
of current assets and the amount of current liabilities. It is
essentially a tool for measuring short-term liquidity and solvency
position of firms. In other words, it may be stated that this ratio
is taken to measure the margin of safety of current assets over
current liabilities that the management of a company maintains
obtaining business finance from short-term sources. Generally, a
2:1 ratio is considered normal. That is for every two units of
current assets, there is only one unit of current liability. The
reason for prescribing 2:1 current ratio is that all the current
assets do not have the same liquidity, or in short, all the current
assets cannot be immediately converted into cash. The other logic
for prescribing 2:1 current ratio can possiblybe the fact that a
surplus of current assets will remain in the firm as Working
Capital even if all current liabilities are liquidated by it at the
close of its accounting cycle. As with other ratios, there is no
best answer for any particular company and it is the trend in this
ratio which is more important. If the ratio is worsening over time,
and especially if it falls to less than 1:1, the observer would
look closely at the cash flow.Liquidity Ratio = Current
AssetsCurrent LiabilitiesAll commercial banks sampled for this
during the period under investigation were unable to attain the
required current ratio of 2:1, or at least the 1:1. The table above
revealed a highest liquidity ratio of 1.22 in respect to FCMB
followed by Access bank and sterling bank with a liquidity ratio of
1.17 and 1.10 respectively. Eco-Bank which has a better performance
using both profitability and liquidity ratios has a very low
current ratio of 0.95. This implies that all the banks have not
maintained enough current assets to meet their short term financial
assets as and when they fall due.The management of the banks in
most cases were prudent enough to have kept more than one naira of
current assets ready to pay for every one naira of current
liabilities that may fall due. Current Liquidity Ratio measures the
ability (available short-term funds) of the firm to meet its
short-term financial obligations as and when they fall due. Net
Worth to total AssetsThe net worth to total assets measures the
total asset contribution to the total worth of the company during
the period under investigation. The table above revealed the
highest net worth to total asset of 0.32 in respect to FCMB
followed by Access Bank and Eco-Bank with 0.29 and 0.17
respectively. Sterling bank has the least net worth ratio of 0.09.
these values revealed poor contribution of total assets in
financing the operations of the Company.Leverage RatiosBanks Years
5 year Average L/TD5 year Average CAR
ACCESS BANK PLC2009-20131.770.32
STERLING BANK PLC2009-20131.490.11
ECO-BANK PLC2009-20130.560.17
FCMB2009-20131.750.29
Leverage ratios are ratios used to calculate the financial
leverage of a company to get the idea of the companys method of
financing or to measure its ability to meet its financial
obligation.
Loan to Total DepositAlso known as LTD ratios, is a ratio
between the banks total loans and total deposits. If it is lower
than 1, the bank relied on its own deposit to make loans to its
customers without any outside borrowing. If on the other hand the
ratio is greater than 1, the bank borrowed money which is re-loaned
at higher rate rather than relying entirely on its own deposits.
Banks may not be earning optimal returns if the ratio is too low.
If the ratio is too high, banks might not have enough liquidity to
cover any unforeseen funding requirements or economic crises. It is
a commonly used statistics for assessing bank liquidity. The table
above revealed the highest LTD ratio of 1.77 in respect to access
bank, followed by FCMB and sterling bank with an LTD ratio of 1.75
and 1.49 respectively. Eco-Bank has the lowest LTD ratio of
0.56.The implication of this data is that even though, the three
banks (Access Bank, FCMB and Sterling Bank) might not have enough
liquidity to cover any unforeseen funding requirements or economic
crises since their ratios are slightly above 1, the three bankswere
able to borrowed money which were re-loaned at higher rate rather
than relying entirely on its own deposits. While in case of
Eco-Bank, the data in the table further shows that the bankwas not
earning optimal returns since the ratio was too low (i.e. less than
1). Capital Adequacy RatiosAlso known as capital to risk (weighted)
assets ratio (CRAR). This is the ratios of a banks capital to its
risks. National regulators track a banks CAR to ensure that it can
absorb a reasonable amount of loss and complies with statutory
capital requirement. This ratio is used to protect depositors and
promote the stability and efficiency of the financial system around
the world. The data in the table above reveal the highest capital
adequacy ratio of 0.32 in respect to Access Bank followed by FCMB
and Eco-Bank with CAR of 0.29 and 0.17 respectively. Sterling Bank
has the lowest CAR of 0.11. This implies that the banks under study
here cannot absorb a reasonable amount of loss and thus does not
comply with statutory capital requirements.4.2.1 Presentation of
ResultsThis section of the chapter presents and analyses data
collected from the annual audited accounts of selected banks in
respect to the variables employed in the study from the period
2009-2013.Data in respect to profitability ratios, liquidity ratios
and leverage ratios were taken as a separate pair and inputted in
the statistical package for social sciences (SPSS) version 20 to
compute the paired sample t-test. The output is herein presented
below:Table 4.1: Paired Samples Statistics
MeanNStd. DeviationStd. Error Mean
Pair 1ROA.018720.01321.00295
CR1.109920.15033.03361
Pair 2ROA.018720.01321.00295
NW.167720.10004.02237
Pair 3ROA.018720.01321.00295
LTD.642920.18249.04081
Pair 4ROA.018720.01321.00295
CAR.224920.11411.02552
Source: SPSS Version 20 Output
The mean value of the return on assets (ROA) that measures how
much a bank is able to generate for each naira in asset stood at
0.0187% with a fluctuation of 0.01321% while the mean of current
ratio which indicates the ability banks to meet their current
obligations effectively with the liquid assets (CR) stood at 1.1099
with a fluctuation of 0.15033. This reveals a higher mean in
respect to CR in comparison to ROA. The standard deviation between
ROA and CR indicates that the volatility is higher in respect to
capital adequacy ratio. The poor performance in terms of ROA
further indicates that in spite of the asset intensity, banks could
not utilize them well to generate comparable revenue to justify the
increase in assets resulting from various banking sector reforms
such as the mergers and acquisition.The mean of net worth to total
assets (NWTA) stood at 0.1677 in with a fluctuation of 0.10004.
This reveals that the assets were financed more with shareholders
equity funds. This is a plausible condition when related to the
analysis of ROA which has a much lower mean of 0.0187. The mean of
loan to deposit (LTD) ratio reflect a mean of 0.6429 with a
fluctuation of 0.18249. In spite of this mean been much higher than
the mean of ROA, it further reveals that commercial banks are yet
to achieve a more stable financing mix. The mean capital adequacy
ratio (CAR) of 0.2249 represents the funds provided by shareholders
for the financing of the banks operations as against the customers
deposits. This may be interpreted that the banks are more at risk
of dependency on external funding because the operations are funded
more with customers deposits that can be demanded for at any time
and less of equity. This mean is however higher than the mean of
ROA which indicates that capital adequacy ratios reflect a higher
performance measure.The interpretation of the descriptive
statistics implies that the financial performance of commercial
banks has deteriorated, and became riskier. Therefore, the results
show that in each pair, liquidity and leverage ratios reflect a
mean very much higher than profitability ratios.Table 4.2: Paired
Samples Correlations
NCorrelationSig.
Pair 1ROA & CR20-.293.210
Pair 2ROA & NW20.455.044
Pair 3ROA & LTD20-.135.570
Pair 4ROA & CAR20.068.776
Source: SPSS Version 20 Output
Table 4.2 above presents the paired sample correlation for all
the variables under investigation. The correlation results above
revealed a very weak and insignificant relationship between return
on assets (ROA), current ratio (CR), loan to deposit (LTD), capital
adequacy ratio (CAR) and net worth to total assets (NWTA). However,
the correlation results revealed a weak and significant
relationship between profitability ratio liquidity and leverage
ratios. However, the mean net worth (NW) indicate a weak but
significant relationship between ROA and NW
Table 4.3: Paired Samples Test
Paired DifferencestDfSig. (2-tailed)
MeanStd. DeviationStd. Error Mean95% Confidence Interval of the
Difference
LowerUpper
Pair 1ROA
CR-1.09121.15472.03460-1.16362-1.01879-31.54119.000
Pair 2ROA NW-.14897.09476.02119-.19332-.10462-7.03119.000
Pair 3ROA LTD-.62418.18474.04131-.71064-.53772-15.11019.000
Pair 4ROA CAR-.20616.11398.02549-.25951-.15282-8.08919.000
Source: SPSS Version 20 outputThe table 4.3 presents the result
of the paired sample t-test return on assets (ROA), current ratio
(CR), and net worth to total assets (NWTA) loan to deposit (LTD)
and capital adequacy ratio (CAR) of Nigerian commercial banks. The
result reveals an overall mean and standard deviation in respect to
return on assets (ROA) and current ratio (CR), with a fluctuation
of 2.064%. The calculated t-value at a degree of freedom of 19
stood -31.541. The level of significant is estimated at 0.000 which
is more than 0.05 or 5% level of significant for a two tailed test
thus indicating that the test is statistically significant.Also,
the result reveals an overall mean and standard deviation in
respect to ROA and NW to be 0.14897 with a fluctuation of 0.09476%.
The calculated t-value at a degree of freedom of 19 stood at
-7.031. The level of significant is estimated at 0.000% which is
less than 0.05 or 5% level of significant for a two tailed test
thus indicating that the test is statistically insignificant.More
so, the result reveals an overall mean and standard deviation in
respect to ROA and LTD to be -0.62418% with a fluctuation of
0.18474. The calculated t-value at a degree of freedom of 19 stood
at -15.110. The level of significant is estimated at 0.000% which
is less than 0.05 or 5% level of significant for a two tailed test
thus indicating that the test is statistically
insignificant.Finally, the result reveals an overall mean and
standard deviation in respect to ROA and CAR to be -0.20616 with a
fluctuation 0.11398. The calculated t-value at a degree of freedom
of 19 stood at -8.089. The level of significant is estimated at
0.000 which is less than 0.05 or 5% level of significant for a two
tailed test thus indicating that the test is statistically
significant.4.3Test of Hypotheses This section of the chapter
provides a test of the research hypotheses. Table 4.3 displays the
calculated t-values for all variables paired and their level of
significance. These level of significance shall be used to compare
with 5% level of significance for a two tailed test to enable a
decision to be made as to whether to accept or reject the studys
formulated hypotheses. The criteria for the acceptance and
rejection of the studys null hypotheses will be done in line with
the studys decision rule earlier formulated in chapter three.4.3.1
Test of Research Hypothesis OneHo1: There is no significant
difference in performance of commercial banks when measured using
Profitability ratios and liquidity ratios.Given that the critical
value of t is 2.093 (see appendix ii) and the calculated t-values
for liquidity ratios (CR and NW) are -31.541 and -7.031
respectively (see table 4.3) which lies outside the region of
acceptance, the researcher therefore rejects the null hypothesis
and conclude that there is a significant difference in performance
of commercial banks when measured using Profitability ratios and
liquidity ratios.4.3.2 Test of Research Hypothesis TwoHo2: There is
no significant difference in performance of commercial banks when
measured using Profitability ratios and leverage ratios.Given that
the critical value of t is 2.093 (see appendix ii) and the
calculated t-values for the pair of profitability (ROA) and
leverage ratios (LTD and CAR) are -15.110 and -8.089 respectively
(see table 4.3) which lies outside the region of acceptance, the
researcher therefore rejects the null hypothesis and conclude that
there is a significant difference in performance of commercial
banks when measured using Profitability ratios and leverage
ratios.4.4Discussion of FindingsThis study examined the use of
financial ratios as a tool for measuring organizational
performance. To do this, the study groups the financial ratios
under three categories: profitability ratios, liquidity ratios, and
leverage ratios.In the first objective of the study which seeks to
investigate the use of ratios in the evaluation of financial
performance of commercial banks in Nigeria, the finding from the
observation of the data presented reveal that performance of
commercial banks on a general note could be adjudged to be poor
especially when observed using profitability ratios, liquidity
ratios and leverage ratios.In the test of the first hypothesis of
the study which seeks to examine the extent of the difference in
the performance of commercial banks when measured using
profitability ratios and liquidity ratios, the result of the test
reveals that there is a significant difference in performance of
commercial banks when measured using Profitability ratios and
liquidity ratios. This finding is further affirmed by the result of
the descriptive statistics which revealed the highest mean in
respect to liquidity ratios as compared to profitability ratios.
This implies that liquidity ratios are a better measure of
performance of commercial banks especially when compared with
profitability ratios.Also, the result of the test of the second
hypothesis of study which seeks to examine the extent of the
difference in the performance of commercial banks when measured
using profitability ratios and leverage ratios, the result of the
test reveals that there is a significant difference in performance
of commercial banks when measured using Profitability ratios and
leverage ratios. This finding is further affirmed by the result of
the descriptive statistics which revealed the highest mean in
respect to leverage as compared to profitability ratios. This
implies that leverage ratios are a better measure of performance of
commercial banks especially when compared with profitability
ratios. These findings are consistent with findings of Boune and
Neely; (2003) who examined implementing performance measurement
system and concludes that liquidity ratios are better measure of
business performance as compared to profitability ratios.
CHAPTER FIVESUMMARY, CONCLUSION AND
RECOMMENDATIONS5.1SummaryThis study was carried out to empirically
access the use of financial ratios as a tool measuring business
performance. The study specifically sought to examine whether
profitability ratios reflect a better measure of performance as
compared to liquidity ratios and leverage ratios. The followings
are the summary of major findings of this study.1. The performance
of commercial banks when evaluated using profitability ratios
liquidity ratios and leverage ratios, during the period under study
could be adjudged to be abysmal.1. There is a significant
difference in the performance of commercial banks when measured
using profitability ratios and liquidity ratios. Thus, liquidity
ratios are better measure of performance of commercial banks when
compared with profitability ratios.1. There is a significant
difference in the performance of commercial banks when measured
using profitability ratios and leverage ratios. Thus, leverage
ratios are better measure of performance of commercial banks when
compared with profitability ratios.5.2ConclusionFinancial
statements contain lots of information summarized in figures.
Viewed on the surface, they do not provide enough information about
the validity of the reporting entity. Thus, they need to be
analyzed by means of financial ratios to unveil the mass truth
hidden in them, and to enhance decision making. This study
investigate the use of ratios in evaluating the financial
performance of commercial banks in Nigeria with the view of
ascertaining whether there is a significant difference in the
performance of commercial bank in Nigeria when measured using
profitability ratio, liquidity ratios and leverage ratios. In line
with the findings of this study, the researcher therefore comes to
the conclusion that commercial banks in Nigeria have performed
abysmally as evaluated using financial ratios and that there is a
significant difference in the performance of commercial bank when
performance is accessed using profitability ratios, liquidity and
leverage ratios.5.3Limitations of the StudyThe following are the
potential limitations of the study that should be taken into
considerations.The research was mainly conducted using secondary
data. The other data collection methods had not been considered as
a result there may not be 100% accuracy. In addition to this, data
representing the period of 2009 to 2013 were used for the study.
The research has compiled a large database of Nigerian commercial
banksdata that demonstrate what can be done even with the
limitations of currently available data.5.4Recommendations In line
with the findings of the study, the following recommendation has
been put forward.Management of commercial banks in Nigeria should
make it mandatory to monitor performance using financial ratios as
financial ratios helps to identify at the early stage the health
status of business organizations. The management of commercial
banks should endeavour to employ accountants and other financial
experts who are vast in the area of financial ratio analysis as
financial analyst of the company. Such analysts should be trained
from time to time to help update their knowledge.5.5Suggestions for
Further ResearchAt this juncture I would like to categorically
state here that this study does not provide an end to the
examination of the use of ratios as a tool for measuring the
performance of organization using ratio analysis, rather it is a
means to an end. The study therefore suggests that prospective
researchers should examine other forms of ratios such as cash flow
ratio not adequately examine in this study.More so, this study made
use of a very large firm (commercial banks) hence any further
research in this form should be directed towards small scale
enterprises which predominate the Nigerian business climate.
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APPENDIX IDATA FROM BANKS ANNUAL REPORTShareholders equityNet
profit after taxTotal assetsTotal deposit
N000N000N000N000
ACCESS BANK PLC
Year:
2009173,151,02322,885,794647,574,719409,349,424
2010182,504,81412,931,441726,960,580440,542,115
2011185,836,45513,660,448945,966,603522,599,666
2012237,624,21136,353,6431,515,754,4631,093,979,220
2013245,181,99726,211,8441,704,094,0121,217,176,793
STERLING BANK PLC
Year:
200922,141,994(9,188,328)205,640,827160,470,381
201026,320,4873,198,009259,579,523199,274,284
201140,953,1154,644,220504,427,737406,515,735
201246,642,3946,953,539580,225,940463,726,325
201343,457,8968,274,864707,797,181570,511,097