Introduction To Bank Ratio Analysis
Bank officials do everything possible to ensure that any money parted with in form of loans and draft are reposition the finance at when due. It is because of this consciousness that further steps are taken to analyse the financial statements of business organisations to ensure safety of any advance given out to them. And this brings us to ratio analysis which is the comparison of two variables to establish facts and arrive at a conclusion as to the performance of the business.
This ratio analysis includes the Net worth. Gearing, Debt ratio, Liquidity ratio and Performance ratio. All of these ratios have sub items and we shall be taking them one after another. Let us look at a typical Balance Sheet ratio analysis. The Net worth of any company show’s its worth in the present market value. It is the addition of all capital items, Goodwill and others. When a company is having a debt ratio, there is always an additional loan which will help to increase the profitability of the company thereby increasing the company’s return on investments and a complete benefit to the shareholders.
Bank’s Liquidity Ratio and How It Works
When you talk about a bank’s liquidity ratio you must includes the banks current ratio, Debtor’s turnover, Stock turnover, Acid test ratio, Creditor’s turnover, Working capital/sales ratio of the company. Here is what liquidity ratio does for you, it helps in testing the ability of the company to pay all its current liabilities as at when due and not to default in their payments. The thing is that, an ideal current ratio which is expected to be at 2:1 so as to meet demands by Creditors as they fall due.
Note that this should not be taken as hard and fast rule because business differs. What matters is the trend in the business cycle. This is more reliable than the current ratio because all the current assets included in the calculation of liquid ratio can be turned into cash obsolete ones in it. The ideal is 1:1, but it is the trend of the ratio overtime that matters much because it will reveal whether the business is improving or deteriorating which may be manifested in gradual decline. The idea is to establish the item of credit given by the Creditors, in essence the length of time it takes the business to pay its suppliers of goods they receive on credit.
Questions That Bankers Ask Borrowers
Under normal circumstances of an interview of the borrower or its representative, the following questions would likely be the questions that the banker will ask and the possible answers that should be given to enable the bankers to take a decision;
- Are the creditors wide spread?
- Are analysis of the creditor to be sought for?
- Are the goods saleable?
- Is there likely to be pressured from creditor that many bring down the business?
- If creditor’s turnover is getting worse, then the following questions should arise.
- Has he used the creditor’s money to purchase fixed assets?
- Did he suffer a substantial loss that brought hardship on him making it difficult for him to pay his creditors?
- Is he making stock piling pending a projected and forecasted greater demand in future?
Stock Turnover In Business
The formula to calculate stock turnover;
= Stock/Cost of goods sold x 365 days or Stock/sales x 365 days
This is the average period of time it takes a business to turnover its stock. The more the stock turnover the more profitable the business is.
Reasons For Increases In Stock Turnover
– He may be stock piling
– There may be stocks that are difficult now to be sold. Therefore inquiry should be said be send to the directors to explain the reasons behind the trend.
Working Capital On Sales Made For business
This is meant to measure the amount of working capital the company’s operations is riding on. For example, John Kay Ltd has the following statement and you are required to analyse it in trends of a company’s working capital to sales figure.
Current capital N65,000 N70,000 N85,000
Current Liabilities N40,000 N60,000 N80,000
Working Capital N25,000 N10,000 N5,000
Sales N150,000 N200,000 N260,000
Working Capital N25,000 N10,000 N5,000
Sales N150,000 N200,000 N260,000
For the above trend, the relationship between the working capital and sales is declining. This also means that the company is trading with a low working capital level whereas the level of sales is increasing faster.
Performance Ratio
The reason for the above relationship between gross profit figure and that of sales may be as follows;
- The company have reduced their selling price which causes sales to increase while the corresponding profit remains relatively low.
- -The cost of goods purchased has increased substantially. This may be brought about by inflation.
A business must make profit to pay a reward to the people who put money into it, in essence investors must get there money back at any cost, and the size of profits should therefore be sufficient to provide a suitable large return on the amount of capital invested. For example, a business makes a profit of N80,000, Sales of N800,000 and has capital employed in the business valued at N2,000,000, its profit and sales ratio would then be 20% but it s return on capital employed is only 8%. This is not a good return for the investors in a business like this.
How To Judge The Significance Of Return On Investment
- a) To Measure the trend of changes in return on investment over time
- b) To compare the returns on investment of different business in the same industry, remembering that capital employed must be measure consistently for all the business in the comparison.
- c) To compare the actual returns on investment achieved against a planned target or budget.
- d) To compare the return on investment (ROI) against the market returns hat investors might currently expect to earn on their investments. Though this method should be used with caution, as market returns on investments and accounting returns based on returns in financial statements are properly comparable.