Professional Documents
Culture Documents
By
IBRAHIM UMAR
PGA/09/07766
M.Sc. Assignment
Submitted to
Jan. 2010
3Financial Statement Analysis: A Tool for Performance Evaluation
ABSTRACT
There are various methods or techniques that are used in analyzing financial
statements, such as comparative statements, schedule of changes in working
capital, common size percentages, trend analysis and ratios analysis.
INTRODUCTION
1.1 Background
Although financial statement analysis is a highly useful tool, it has two limitations.
These two limitations involve the comparability of financial data between
companies and the need to look beyond ratios.
Comparison of one company with another can provide valuable clues about the
financial health of an organization (Remi, 2006). Unfortunately, differences in
accounting methods between companies sometime make it difficult to compare
the companies' financial data. For example if one company values its inventories
by the LIFO method and another firm by average cost method, then direct
5Financial Statement Analysis: A Tool for Performance Evaluation
The needs of financial accounting information users are diverse that they find it
difficult to understand the information contained in the statement so presented
by the organization and as such there is need to analyze the statement into
meaningful form for decision making and performance evaluation.
Analysis of banks through financial statements is more difficult than other type of
companies due to the innovation of new and complex financial instruments. One
of the indicators of bank`s performance is the behavior of their stock prices
because it reflects the market’s evaluation of the bank’s performance which is
also used as part of performance evaluation. Moreover, financial management
theories provide many indicators for assessing a bank’s performance.
The main purpose of this research is to analyze the financial statements of the
bank and its development over time as reflected in its reports during three years
from 2004 to 2008.
6Financial Statement Analysis: A Tool for Performance Evaluation
The recent economic crisis and non performing loans cases in the Nigerian
commercial banks have raised question which necessitated this research
undertaking. The study intends to answer the following questions:
The study will provide investors with enough ideas to decide about the
investment of their funds in specific banks in Nigeria. Regulatory authorities (e.g.
IASB) can assess whether banks are following the accounting standard or not,
government agencies will gain from the research to analyze taxation due from
banks. It will also aid the selected bank in evaluating its performance over time
and it will be a guide for future research.
This study will analyze only Oceanic banks` performance from 2004 to 2008.
However, there are some reasons for choice of only one bank for the study; the
7Financial Statement Analysis: A Tool for Performance Evaluation
time frame for the research work is too short to obtain data from more banks. The
purpose is neither to investigate how the banks evaluate financial instruments to
report in their financial statements nor to review the banking regulations and the
governance systems. Author will focus only on the financial data available in
financial reports. Another delimiting factor is that the researcher has to only rely
on the financial reports provided by the banks on their websites because insight
information is not accessible. Financial constraints are also obstacle to a wider
study.
8Financial Statement Analysis: A Tool for Performance Evaluation
LITERATURE REVIEW
2.1 INTRODUCTION
Financial statements are prepared to meet external reporting obligations and also
for decision making purposes. They play a dominant role in setting the framework
of managerial decisions. But the information provided in the financial statements
is not an end in itself as no meaningful conclusions can be drawn from these
statements alone. However, the information provided in the financial statements
is of immense use in making decisions through analysis and interpretation of
financial statements (James C. 2002)
Following are the most important tools and techniques of financial statement
analysis (Remi A. 2006):
One application of the vertical analysis idea is to state the separate assets of a
company as percentages of total sales.
10Financial Statement Analysis: A Tool for Performance Evaluation
The main advantages of analyzing a balance sheet in this manner are that the
balance sheets of businesses of all sizes can easily be compared. It also makes
it easy to see relative annual changes in one business (Helfert E. 1997)
Another application of the vertical analysis idea is to place all items on the
income statement in percentage form in terms of sales.
By placing all items on the income statement in common size in terms of sales, it
is possible to see at a glance how each Naira of sales is distributed among the
various costs, expenses, and profits. And by placing successive years'
statements side by side, it is easy to spot interesting trends. Managers and
investment analysis often pay close attention to the gross margin percentage
since it is considered a broad gauge of profitability. The gross margin percentage
is computed by the following formula (Oye A. 2005):
The gross margin percentage tends to be more stable for retailing companies
than for other service companies and for manufacturers. Since the cost of goods
sold in retailing exclude fixed costs. When fixed costs are included in the cost of
goods sold figure, the gross margin percentage tends to increase or decrease
with sales volume. The fixed costs are spread across more units and the gross
margin percentage improves.
Common size statements are also very helpful in pointing out efficiencies and
inefficiencies that might other wise go unnoticed.
11Financial Statement Analysis: A Tool for Performance Evaluation
Ratios can be found out by dividing one number by another number. Ratios show
how one number is related to another. It may be expressed in the form of co-
efficient, percentage, proportion, or rate (Oye A. 2005). For example the current
assets and current liabilities of a business on a particular date are N200, 000 and
N100, 000 respectively. The ratio of current assets and current liabilities could be
expressed as 2 (i.e. 200,000 / 100,000) or 200 percent or it can be expressed as
2:1 i.e., the current assets are two times the current liabilities. Ratio sometimes is
expressed in the form of rate. For instance, the ratio between two numerical
facts, usually over a period of time, e.g. stock turnover is three times a year
(Remi A. 2006)
The ratios analysis is the most powerful tool of financial statement analysis. Ratio
simply means one number expressed in terms of another. A ratio is a statistical
yardstick by means of which relationship between two or various figures can be
compared or measured. Ratios can be found out by dividing one number by
another number. Ratios show how one number is related to another.
• Composite/mixed
ratios or inter
statement ratios
Source: www.accountiingformanagement.com/financial_accounting_ratios.htm
In order to meet the vast needs of financial information user, Femi A. (2006),
provided the following classification as also depicted by (Pandy 2004)
13Financial Statement Analysis: A Tool for Performance Evaluation
PROFITABILITY RATIOS
LIQUIDITY RATIOS
These are the ratios which measure the short term solvency of financial position
of a firm. These ratios are calculated to comment upon the short term paying
capacity of a concern or the firm's ability to meet its current obligations. Following
are the most important liquidity ratios.
• Current ratio
• Liquid / Acid test / Quick ratio
ACTIVITY RATIOS:
Activity ratios are calculated to measure the efficiency with which the resources
of a firm have been employed. These ratios are also called turnover ratios
14Financial Statement Analysis: A Tool for Performance Evaluation
because they indicate the speed with which assets are being turned over into
sales. Following are the most important activity ratios:
Long term solvency or leverage ratios convey a firm's ability to meet the interest
costs and payment schedules of its long term obligations. Following are some of
the most important long term solvency or leverage ratios.
• Debt-to-equity ratio
• Proprietary or Equity ratio
• Ratio of fixed assets to shareholders funds
• Ratio of current assets to shareholders funds
• Interest coverage ratio
• Capital gearing ratio
• Over and under capitalization
This is a collection of financial ratio formulas which can help you calculate
financial ratios in a given problem (Pandy 2004).
Analysis of Profitability
General profitability:
15Financial Statement Analysis: A Tool for Performance Evaluation
Overall profitability:
The ratios analysis is one of the most powerful tools of financial management.
Though ratios are simple to calculate and easy to understand, they suffer from
serious limitations (Pandy 2004).
Although financial statement analysis is highly useful tool, it has two limitations.
These two limitations involve the comparability of financial data between
companies and the need to look beyond ratios
(www.accountingformanagement.com/limitation_of_financial_statement_analysis
Comparison of one company with another can provide valuable clues about the
financial health of an organization. Unfortunately, differences in accounting
methods between companies sometimes make it difficult to compare the
companies' financial data. For example if one firm values its inventories by LIFO
method and another firm by the average cost method, then direct comparison of
financial data such as inventory valuations and cost of goods sold between the
two firms may be misleading. Sometimes enough data are presented in foot
notes to the financial statements to restate data to a comparable basis.
Otherwise, the analyst should keep in mind the lack of comparability of the data
before drawing any definite conclusion. Nevertheless, even with this limitation in
mind, comparisons of key ratios with other companies and with industry average
often suggest avenues for further investigation.
There are various advantages of financial statements analysis. The major benefit
is that the investors get enough idea to decide about the investments of their
funds in the specific company. Secondly, regulatory authorities like International
Accounting Standards Board can ensure whether the company is following
accounting standards or not. Thirdly, financial statements analysis can help the
government agencies to analyze the taxation due to the company. Moreover,
company can analyze its own performance over the period of time through
financial statements analysis.
21Financial Statement Analysis: A Tool for Performance Evaluation
METHODOLOGY
The study, “financial statement analysis: A tool for performance evaluation” used
secondary data for the analysis of financial statement. This is due to the fact that
the source of data is the banks financial statements published and posted to
banks’ web sites.
The population of the study comprises all commercial banks in Nigeria (21 as at
January 2010). A random sampling is used to select one bank out of the twenty
one banks in Nigeria. For the purpose of the study, Oceanic bank is chosen for
analysis.
1. Trend analysis
2. Ratio analysis – only five ratios will be used viz: ROI, EPS, current,
working capital turnover and proprietary ratio.
22Financial Statement Analysis: A Tool for Performance Evaluation
DATA ANALYSIS
Based on the financial statement of the bank the following analysis was
undertaken.
Borrowed funds
Current income tax 286.80 466.48 164.78 191.09 100
Other liabilities 453.59 620.76 176.76 178.80 100
Deferred tax
liabilities 792.27 1434.11 676.94 76.07 100
Retirement Benefit
Obligations 357.59 305.70 348.12 182.58 100
1336.6
current liabilities 2 1055.83 436.41 244.06 100
1423.6
0 1185.99 427.73 250.74 100
RATIO ANALYSIS
Proprietor of 0
equity ratio 0.17 0.22 .10 0.14 0.12
1
Current ratio 1.11 1.21 .03 1.09 1.02
EPS (Naira) 35k 147.17k 102.63 20 27
Working Capital
T/O 0.09 0.16 0.03 0.08 0.02
0
ROI 0.04 0.08 .25 0.19 0.32
24Financial Statement Analysis: A Tool for Performance Evaluation
SUMMARY
Financial statement analysis is one of the useful tools for decision making and
performance evaluation. It is apparent that despite the economic crisis the bank
was able to stable above the sinking level.
The ratios indicate improvement though at a reduced rate. The economic crisis
was noticed using the ratio analysis. EPS rose from 20 to 102 to 147 in 2004
through 2007 but in 2008 it dropped to 35k. Return on investment had an upward
– downward trend with 2008 recording the least figure.
CONCLUSION
In conclusion, the study is able to able to come up with some reasonable as well
as educative piece. The combination of the techniques for financial statement
analysis brought about the hidden features of financial statement. By mere
looking at financial statements does not give an investor or analyst enough
information.
Despite the fact that financial statement analysis techniques, there are still
unresolved issues which remain with the data itself (the financial statement). The
effect of inflation, historic cost issues are major issues to be talked.
REFERENCE
8. James Van Horne (2002) Financial Management and Policy, 12th Edition, Pearson Edu.
USA
9. J.H. Clemens and L.S. Dyer. (1986) Balance Sheets And The Lending Banker: An
Assessment Of Accounting Statements And Their Interpretation In Relation To Bank
Advances. 6th ed. Europa, London.
10. Oye Akinsulire (2006) Financial Management, 5th Edition, Ceemol Nigeria Ltd, Lagos
11. Pandy I.M. (2004) Financial Management, 8th Edition, Vikas Pub. India
12. Remi Aborode (2006) Practical Approach to Advanced financial Accounting, 2nd Edition,
masterstroke Consulting, Lagos
13. Roberts K. and Sharon L. (2002) Rich Dad’s Guide to Investing, Time Warner Corp. USA.
14. Stephen H. Penman.2007 Financial Statement Analysis and Security Valuation, 3rd ed.
McGraw-Hill Irwin, Boston.