ST.

MARY’S UNIVERSITY

FINANCIAL PERFORMANCE OF BANKING

INDUSTRY, IN CASE OF THREE ETHIOPIAN
PRIVATE BANK

Department Of

Group Member: -

Submitted to:
 Submissio
n date:

ABSTRACT
Banks today are the largest financial institutions around the world, with branches and
subsidiaries throughout everyone’s life. Banks are facing financial risks when they are
operating. In this paper, financial statements of Companies have been used to analyze the
financial performance and their trend for the year under study. According to the theoretical
analysis we conducted we have drawn some conclusion. This paper has specified few
conclusions about financial statement of Ethiopian banking system we found that in Ethiopia
there is no any responsible organization to determine and to state industry average on every
factors (dependent and independent) and ratios for banking industry. Beside The liquidity ratios
measure of the banks to meet its short-term obligations. Generally, the study indicates that firms
have a small margin safety to cover their short-term obligations, but according to international
banking system it is very poor. Finally, the activity ratios which measures the effectiveness and
efficiency of the firms to manage and control its assets, is technically efficient and recommended
for the existence of a big firm to control all the financial system of the Ethiopian Banks.

Key word: - Financial statement, fixed to total asset, leverage ratio, liquidity ratio, current ratio.

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 Table of Contents
ABSTRACT....................................................................................................................................................1
CHAPTER ONE..............................................................................................................................................3
1. INTRODUCTION.......................................................................................................................................3
1.1 Background of the study....................................................................................................................3
1.2 Background of the Organization........................................................................................................4
1.3 Statement of the problem.................................................................................................................4
1.4 Objectives of the study......................................................................................................................4
1.4.1. General objective of the study...................................................................................................4
1.4.2. Specific objectives of the study..................................................................................................4
1.6 Significance of the study....................................................................................................................5
1.7 Scope of the study.............................................................................................................................5
1.8 Limitations of the study.....................................................................................................................5
1.9 Research Methodology......................................................................................................................5
1.9.1 Research design..........................................................................................................................5
1.9.2 Types of data and source............................................................................................................5
1.9.3 Method of data collection and technique...................................................................................6
1.9.4 Method of data analysis.............................................................................................................6
CHAPTER TWO.............................................................................................................................................6
2. REVIEW OF RELATED LITERATURE...........................................................................................................6
2.1 Definition of financial statement.......................................................................................................6
2.2 Process of financial statement analysis.............................................................................................8
2.2.1 Preparation.................................................................................................................................8
2.2.2 Computation...............................................................................................................................9
2.2.3 Evaluation and interpretation.....................................................................................................9
2.3 Tools and techniques of financial analysis.........................................................................................9

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 2.3.1 Vertical and horizontal analysis..................................................................................................9
2.3.2. Ratio analysis...........................................................................................................................10
2.3.3 Common size analysis...............................................................................................................22
2.3.4 Index analysis............................................................................................................................23
2.4 Classification of financial statement analysis accounts to users......................................................23
2.4.1 External analysis.......................................................................................................................23
2.4.2 Internal analysis........................................................................................................................23
2.5 Review of Empirical Studies.............................................................................................................23
CHAPTER THREE........................................................................................................................................24
3. DISCUSSIONS AND ANALYSIS.................................................................................................................24
3.1 Introduction.....................................................................................................................................24
3.2 Financial Analysis.............................................................................................................................24
3.2.1 Total Income, Total Expenses, and Net Profit...........................................................................24
3.2.2 Total Deposits and Total Loans & Advances.............................................................................25
Table 3.2:-Shows Total deposits and total Loans & advances................................................................25
3.2.3 Interest Income and Interest Expense......................................................................................25
Table 3.3:- Interest income and interest expenses................................................................................25
3.2.4 Total Assets and Shareholders’ equity......................................................................................25
3.3 Ratio Analysis...................................................................................................................................26
3.3.1 Liquidity Ratios.........................................................................................................................26
3.3.3 Leverage Ratio..........................................................................................................................30
Table 3.16:- Non Performing Loans to Total Loan Ratio (NPTL).............................................................32
3.3.4 Activity Ratios...........................................................................................................................33
3.3.5 Marketability Value Ratio.........................................................................................................34
CHAPTER FOUR..........................................................................................................................................35
4. CONCLUSIONS AND RECOMMENDATIONS............................................................................................35
4.1 Conclusions......................................................................................................................................35
4.2 Recommendations...........................................................................................................................35
REFERENCE................................................................................................................................................36

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 CHAPTER ONE

1. INTRODUCTION
1.1 Background of the study
Financial statement analysis is an integral and important part of the broader field of business
analysis for financial decision in a firm. Business analysis is the process of evaluating a
company’s economic prospects and risks. This includes analyzing company’s business
environment, its strategies, and its financial position and performance. Business analysis is
useful in a wide range of business decisions, such as whether to invest inequity or in debt
securities, whether to extend credit through short- term or long-term loans, how to value a
business in an initial public offering. Also Financial statement analysis is the application of
analytical tools and techniques to general-purpose financial statements and related data to derive
estimates and inferences useful in business analysis. Financial statement analysis is an important
and integral part of business analysis. The goal of business analysis is to improve business
decisions by evaluating available information about a company’s financial situation, its
management, its plans and strategies, and its business environment (Bergha and Houston 2005).

Financial statement analysis is based on the result of financial statements in a given period and
shows financial strength and weaknesses, this enables the management to know financial
strength of the firm and to be able to spot out financial weakness of the firm to take suitable
corrective measures. Thus, financial statement analysis is the base for making plans, before using
any forecasting and planning statement analysis is the base for making plans, before using any
forecasting and planning procedures. (James mort 1997)

In a particular, service giving organization should provide their service efficiently and effectively
to bring their business. Therefore, financial statement analysis prepared to predict the amount of
expected returns, to assess the risks associated with those returns, to improve the firm’s
performance.

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1.2 Background of the Organization
We selected three banks, for our study, we chose the banking industry to show how financial
management is help full for the process of evaluating a company’s economic prospects and risks.
Additionally, it is easy to use financial management analytical tools for financial decision in a
firm. We identified three banks in the same industry (private) with the same age. For
confidentiality we didn’t specified the name organizations and their data.

1.3 Statement of the problem

The objective of financial statements is to provide information about the financial position,
performance and changes in financial position of an enterprise that is useful to a wide range of
users in making economic decisions. Owners and managers require financial statements to make
important business decisions that affect its continued operations. (Levine 2005)

Hence, this became the basis of the study. And further more numerous studies argues that the
efficiency of financial intermediation affects economic growth while other indicators that bank
insolvencies loan result in systematic cries which have adverse consequences for economy as a
whole (Levine 2005).

The researcher has tries to fill this lack of evidence by extending the issue to the specific context
of the company. Therefore, the aim of this study is to evaluate financial statement analysis of the
banking to provide some comments by observing several financial ratios, analyzing trends of
various elements of financial statement of three banks for oneyear performance results, and to
improve its banking business.

1.4 Objectives of the study

1.4.1. General objective of the study
The overall objective of this study was to evaluate financial statement (ratio analysis) and to
show how the financial statement analyses a useful tool for decision makers of the banking
industry.

1.4.2. Specific objectives of the study

Based on the above general objective, the following are the specific objectives of the study

 To assess the firms liquidity position.

 To assess how to manage debt of the firms.

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  To assess how effectively generate profit from its asset.
 To evaluate how effectively the companies is utilizing its assets.
 To assess the marketability value of the companies.

1.6 Significance of the study

The significance of the study is to help the management of Banking industry and others to know
how financial statement analysis could help them understand the financial contains in financial
statements and enhance their business decisions.

1.7 Scope of the study

In view of the impossibility of covering every type of financial statement, this study deals with
the financial statement analysis that would be focus on three private banks, which started their
business approximately in the year (the same age). Due to proximity and cost saving the one year
financial statement 2018 were used. However, other analytical techniques such as vertical
analysis would not be explained and illustrated.

1.8 Limitations of the study

The researcher would suspect the following constrains, such as;

 Financial source is not sufficient to gather all relevant information.

 The time allocated for data collections is not sufficient to gather all the relevant
information.
 And lack of experience in research activity

1.9 Research Methodology

1.9.1 Research design

The researcher would use a descriptive research design method in order to meet research
objectives and in order to test or answer the research question. Particularly a case study method
is appropriate for this research design. This type of research is used to describe the companies’
current performance and also the companies existing performance.

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1.9.2 Types of data and source
The researcher would use secondary data and primary data. A secondary source of data was
gathered from the organization manuals, and documents, financial reports, audit reports and from
the companies’ web site. Interview will be used as primary data source.

1.9.3 Method of data collection and technique

The researcher would collect data from financial statements of banks by referring financial report
of the bank and internet that is important to the study in the case of secondary data and interview
will be used as a primary data collection technique from responsible employees and
management. Then the data’s would be organized, analyzed and expressed in the form of tables
and ratios.

1.9.4 Method of data analysis

In order to evaluate the financial performance of the banks the researcher would use quantitative
method. In addition in this study process, different types of data’s would collect for the analysis,
describe, summarize, classify, and present in simplified and clarified form. In addition, collected
data would be analyzed using descriptive method and presented in the form of tables, graphs,
percentages and ratios to know the relationship between current and long term, fixed to total
asset , leverage ratio , liquidity ratio , current ratio cash ratio profitability ratio return on asset ,
return on equity. Financial performance of the bank in terms of the four financial performance
indicators; Credit quality, Liquidity, Profitability and Efficiency ratio analysis would be used to
answer the hypothesis or the research question for the significant difference between the
financial performance indicator ratios.

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 CHAPTER TWO

2. REVIEW OF RELATED LITERATURE

2.1 Definition of financial statement
Financial statement analysis is the application of analytical tools and techniques to general-
purpose, financial statements and related data to derive estimates and inferences useful in
business analysis. Financial statement analysis is an important and integral part of business
analysis. The goal of business analysis is to improve business decisions by evaluating available
information about a company’s financial situation, its management, its plans and strategies, and
its business environment.
Financial analysis is the use of financial statements to analyze a company’s financial position
and performance, and to assess future financial performance.
According to the American Institute of Certified Public Accountants, "Financial Statement
reflects a combination of recorded facts, accounting conventions and personal judgments and
conventions applied which affect them materially. There are major financial statements in
accounting. These are income statements, balance sheet and cash flows statement. The analysis
of these statements combined with preparation and analysis of related financial statements called
financial statement analysis. Financial statements are summaries of the operating, financing and
investment activities of a business. Financial statements should provide information useful to
both investors and creditors in making credit, investment and other business decisions and this
usefulness means that investors can use these statement to predict, compare and evaluate the
amount, cash flows expected to result from those earning. (Pollard, mills & Harrison 2007)

Income statement is the major device for measuring the profitability of a firm over period. It is
also a summary of revenue and expenses, gain and losses ending with net income for a particular
period of time. Balance sheet indicates what the firm owns and how these are financed in the
form of liabilities or ownership interest at a point of time. Balance sheet, also called statement of
financial position presents the financial position of a business enterprise and specific date. A
balance sheet provides a historical summary of assets, liabilities and equity. The financial

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statement designed to show a business entity’s financial position what it owns and what it owes
on a particular date is called balance sheet. (Pollard, mills & Harrison 2007)

Cash flow is to emphasize the critical natures of cash flow to the operations of the firm. The
primary purpose of cash flow is to provide relevant information about the cash receipts and cash
payment of an enterprise during a period. Cash flow generally represents cash or cash equivalent
items that can easily by converted into cash within 90 days. The information contained in these
statements enable the users to have a proper judgment about the operating performance, financial
strength and weakness of the firms. This enables the management to know financial strength of
the firm to be able to spot out financial weakness of the firm to take suitable corrective measures.
Plan of the firm is based on the firm’s financial strength and weakness. Thus, financial analysis
is the base for making plans before using any forecasting and planning procedures. The
statement’s value it that it helps users evaluate liquidity, solvency and financial flexibility.
Liquidity refers to the “nearness to cash “of assets and liabilities. Solvency refers to the firm’s
ability to pay its debt’s as they mature and financial flexibility refers to a firm’s ability to
respond and adapt to financial adversity and an expected needs and opportunities (Kieso 1998).

Financial forecasting allows the financial manger to anticipate events before they occur
particularly the need for raising funds externally. An important consideration is that growth may
call for additional source of financing because profit might be antiquating to cover the net build
up in receivables, inventory and other asset account. Financial statement analysis can also be
defined as the process of giving meaningful interpretation to the figure in the financial statement,
so that every user could understand it easily and use it as a tool for decision making.

Financial statement analysis allows mangers, investors and creditors as well as potential
investors and creditors, to reach conclusion about financial status of a firm

 The focus of financial analysis is on key figures in the financial statements and
significant relationships that exist between them.
 The analysis of financial statements is a process of evaluating relationships between
component parts of financial statements to obtain a better understanding of the firm’s
financial condition and performance.

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  Financial analysis helps user to understand the figures presented in financial
statements and serve as a basis for financial decision making
 Financial statement analysis focuses primarily on the balance sheet and income
statement. However data from the following two statements may also be used:-
The statement of retained earnings and
Statement of changes in financial position (Stately. B. Block
seventieth edition)

2.2 Process of financial statement analysis

Financial statement analysis is process of identifying the financial strength and weakness of the
firm by proper establishing relationships between the item of the balance sheet and the profit and
loss accounts. Management of the firm’s ability or parties outside the firm, creditors, investors
and others can undertake financial analysis. The process of financial statement analysis follows
different steps starting from preparation activities to decision making.

2.2.1 Preparation
The preparation step is the first step in the process of analyzing financial statement. The step
includes establishing objectives of the analysis and assembling the financial statements other
pertinent financial data. Financial statement analysis focuses primarily on the balance sheet and
the income statement. However, data from statements of retained earnings and cash flow may be
used. Preparation step is simply objective setting and data collection.

2.2.2 Computation
Computation process involves that application of various tools and techniques to gain a better
understanding of the firm’s financial performance and condition. This process of the analysis
leads to find appropriate ration and percentage by relating financial statement figures. It will use
different techniques like ration analysis, common size analysis and trend analysis. (Fees and
warren 1990).

2.2.3 Evaluation and interpretation

The last step in the financial statement analysis is evaluation and interpretation of the ration. It
involves determining a meaningful analysis that develops conclusions and recommendation
about the performance of the firm and its financial condition. This is the most important step of

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financial analysis, because it gives meaningful interpretation to the computed ration and
percentage.

2.3 Tools and techniques of financial analysis

Different methods are applicable to get better understanding about financial status of the firm
and operating results. The most frequently used techniques in analyzing financial statements are
the following.

2.3.1 Vertical and horizontal analysis

One way of evaluating financial performance is to simply compare financial statements from
period and to compare financial statements with other companies. This can be facilitated by
vertical and horizontal analysis.

Vertical analysis:-compares line items on a financial statement over an extended period of time.
This helps the analysis to spot trends re-state financial statements to a common size for quick
analysis. For the balance sheet, the total asset will be used as a base (100%). Different line item
shall be compared on the financial statement to these bases and expresses the line items as a
percentage of the base. By expressing balance as percentage, the analyst can easily notice that
the firm’s expenses or others are trending up while costs of goods sold are more down, this may
require further to determining what is behind these trends(Needless Belverd. E 1998)

Horizontal analysis:-looks at the percentage change in a line item from one period to the next.
This helps to identify trends from the financial statements. Once we spot trend we can dig deeper
and investigate why the change occurred. The percentage change is calculated as follows; birr/$
amount per year two –birr/$ amount year one.

2.3.2. Ratio analysis

Ratio analysis is a powerful tool of financial analysis. A ratio is defined as “the indicated
quotient of two mathematical expressions” and as “the relationship between two or more things”.
In financial analysis, a ratio used as a benchmark for evaluating the financial position and
performance of a firm. Absolute accounting figures reported in the financial statements do not
provide a meaningful understanding figure conveys meaning when it related to some other
relevant information, and also ration analysis is:-

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  A single figure by itself has no meaning but when expressed in terms of related
figures, it yields significant inferences.
 A ratio analysis standardized financial data by converting birr figures in
financial statement into ration. A financial ration is mathematical (numeric or
quantitative) relationship among several numbers usually stated in the form of
percentage or time.
 A ration analysis helps us to draw meaningful conclusions and make
interpretation about a firm’s financial condition and Performance.

Financial ratios are designed to measure almost any aspect of firm’s performance. In general,
analyst use ratio as one tool in identifying areas of strength or weakness in a firm. Ration,
however, tend to identify symptoms rather than problems. Ratios whose value is judged to be
different or unusually high may help identify a significant event but will seldom provide enough
information peruse to identify the reasons for an event’s occurrence.

2.3.2.1 Types of ratios

Several ratios, calculated from the accounting data can be grouped into various classes according
to financial activity or function to evaluate. As stated earlier, the parties interested in financial
analysis to evaluate every aspects of the firm’s performance. In view of requirements of the
various users of ratios, they may classified in to the following four important categories,

A. Liquidity ratio
B. Profitability ratio
C. Leverage ratio
D. Activity ratio
A. Liquidity ratio

Liquidity ratios measure the ability firm to meet its short term obligation and reflect the short –
term financial strength or solvency of a firm. It is extremely essential for firm to be able to meet
its obligations as they become due. In fact, analysis of liquidity needs the preparation of cash
budgets and other current assets to current obligations provide a quick measure of liquidity. A
firm should ensure that it does not suffer from lack liquidity. And it does not have excess
liquidity. The failure of company to meet its obligation due to lack of sufficient liquidity will
result in poor credit worthiness, loss of creditor’s confidence or even in legal tangle resulting in

9
the closure of the company. A very high degree of liquidity is also bad; idle assets. Therefore, it
is necessary to maintain a proper balance between high liquidity and less liquidity. Liquidity
ratios indicate the ability of the firm to meet recurring financial obligations. Liquidity is
important for the firm to avoid defaulting on its financial obligations and, thus, to avoid
experiencing financial distress (Ross, Westerfield, Jaffe 2005). These ratios measure ability of
the firm to meet its short-term obligations, maintain cash position, and collect receivables. In
general, sense, the higher liquidity ratios mean bank has larger margin of safety and ability to
cover its short-term obligations. Because saving accounts and transaction deposits can be
withdrawn at any time, there is high liquidity risk for both the banks and other depository
institutions. Banks can get into liquidity problem especially when withdrawals exceed new
deposit significantly over a short period of time (Samad & Hassan 2000). There are several
measures for liquidity. The most common rations, which indicate the extent of liquidity or lack
of it, are

1. Cash Deposit Ratio (CDR)

2. Loan Deposit Ratio (LDR)
3. Loan to Asset Ratio (LAR)
1. Cash Deposit Ratio (CDR)

Cash in a bank vault is the most liquid asset of a bank. Therefore, a higher CDR indicates that a
bank is relatively more liquid than a bank, which has lower CDR. Depositors’ trust to bank, is
enhanced when a bank maintains a higher cash deposit ratio. CDR is calculated as under:

Cash
Cash Deposit Ratio =
Deposit

2. Loan Deposit Ratio (LDR)

Loan to deposit is the most important ratio to measure the liquidity condition of the bank. Bank
with Low LDR is considered to have excessive liquidity, potentially lower profits, and hence less
risk as compared to the bank with high LDR. However, high LDR indicates that a bank has taken
more financial stress by making excessive loans and shows risk that to meet depositors’ claims
bank may have to sell some loans at loss. LDR is calculated as under:

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 Loan
Loan Deposit Ratio =
Deposit

3. Loan to Asset Ratio (LAR)

Like LDR, loan to assets ratio (LAR) is also another important ratio that measures the liquidity
condition of the bank. Whereas LDR is a ratio in which liquidity of the bank is measured in
terms of its deposits, LAR measures the percentage of assets that are tied up in loans. That is, it
gauges the percentage of total assets the bank has invested in loans (or financings). The higher is
the ratio the less the liquidity is of the bank. Similar to LDR, the bank with low LAR is also
considered to be more liquid as compared to the bank with higher LAR. However, high LAR is
an indication of potentially higher profitability and hence more risk. LAR is calculated as under:

Loan
LAR =
Asset

B. Profitability Ratios

Profitability ratios are generally considered to be the basic bank financial ratio in order to
evaluate how well bank is performing in terms of profit. For the most part, if a profitability ratio
is relatively higher as compared to the competitor(s), industry averages, guidelines, or previous
years’ same ratios, then it is taken as indicator of better performance of the bank. In the banking
literature, different scholars in measuring bank performance have used many profitability ratios
(Ross, Westerfield, Jaffe 2005). The main performance indicators computed for banks are:

1. Return On Assets (ROA)

2. Return on Equity (ROE)
3. Profit to Expenses Ratio (PER)
4. Return on Deposit (ROD)
5. Income Expense Ratio (IER)
1. Return On Assets (ROA)

Return on assets indicates the profitability on the assets of the firm after all expenses and taxes
(Van Horne 2005). It is a common measure of managerial performance (Ross, Westerfield, Jaffe
2005). It measures how much the firm is earning after tax for each dollar invested in the assets of

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the firm. That is, it measures net earnings per unit of a given asset, moreover, how bank can
convert its assets into earnings (Samad & Hassan 2000). Generally, a higher ratio means better
managerial performance and efficient utilization of the assets of the firm and lower ratio is the
indicator of inefficient use of 28 assets. Firms can increase ROA either by increasing profit
margins or asset turnover but they can’t do it simultaneously because of competition and trade-
off between turnover and margin. ROA is calculated as under:

Net Profit after Tax

Return On Assets =
Total Asset

2. Return on Equity (ROE)

Return on equity indicates the profitability to shareholders of the firm after all expenses and
taxes (Van Horne 2005). It measures how much the firm is earning after tax for each dollar
invested in the firm. In other words, ROE is net earnings per dollar equity capital. (Samad &
Hassan 2000). It is also an indicator of measuring managerial efficiency (Ross 1994). By and
large, higher ROE means better managerial performance; however, a higher return on equity may
be due to debt (financial leverage) or higher return on assets. Financial leverage creates an
important difference between ROA and ROE in that financial leverage always magnifies ROE.
This will always be the case as long as the ROA (gross) is greater the interest rate on debt (Ross,
Westerfiled, Jaffe 2005). Usually, there is higher ROE for high growth companies. ROE is
calculated as under:

Net profit after tax

Return on Equity =
Shareholders ’ Equity

3. Profit to Expenses Ratio (PER)

It measures the operating profitability of the bank with regards to its total operating expenses.
Operating profit is defined as earnings before taxes and operating expenses means total non-
interest expenses. The ratio measures the amount of operating profit earned for each dollar of
operating expense. The ratio indicates to what extent bank is efficient in controlling its operating
expenses. A higher PER means bank is cost efficient and is making higher profits (Samad &
Hassan 2000). PER is calculated as under:

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 Profit before tax
Profit to Expenses Ratio =
Operating Expenses

4. Return on Deposit (ROD)

To most financial analysts, Return on Deposit (ROD) is one of the best measures of bank
profitability performance. This ratio reflects the bank management ability to utilize the
customers’ deposits in order to generate profits. (Samad & Hassan 2000) have used this ratio as a
profitability measurement. ROD is calculated as under:

Net Profit after Tax

Return on Deposit =
Total Deposit

5. Income Expense Ratio (IER)

Income to expense is the ratio that measures amount of income earned per dollar of operating
expense. This is the most commonly and widely used ratio in the banking sector to assess the
managerial efficiency in generating total income vis-à-vis controlling its operating expenses
(Samad & Hassan 2000). High IER is preferred over lower one as this indicates the ability and
efficiency of the bank in generating more total income in comparison to its total operating
expenses. Total income in the study is defined as net spread earned before provisions plus all
other income while the Other Expenses in the income statement are treated as total operating
expense for the study. IER is calculated as under

Total income
Income Expense Ratio =
Total Operating Expenses

C. Leverage ratios

This is a class of ratios, which measures the risk and solvency of the bank. These ratios are also
referred to as gearing, debt, or financial leverage ratios. The extent to which a firm relies on debt
financing rather equity is related with financial leverage. These ratios determine the probability
that the firm default on its debt contacts. The more the debt a firm has the higher is the chance
that firm will become unable to fulfill its contractual obligations. In other words, higher levels of
debt can lead to higher probability of bankruptcy and financial distress. Although, debt is an
important form of financing that provided significant tax advantage, it may create conflict of

13
interest between the creditors and the shareholders (Ross, Wedsterfield, and Jaffe 2005). If the
amount of assets is greater than amount of its all types of liabilities, the bank is considered to be
solvent. “Deposits” constitute major liability for any type of bank whether Islamic or
conventional. To gauge risk and solvency of the bank, measures usually used are Debt Equity
Ratio (DER), Debt to Total Assets Ratio (DTAR), and Equity Multiplier (EM). A bank is solvent
when the total value of its asset is greater than its liability. A bank becomes risky if it is
insolvent. The following are the commonly used measures for a risk and insolvency.

1. Debt Equity Ratio (DER)

2. Debt To Total Asset Ratio (DTAR)
3. Equity Multiplier (EM)
4. Non- Performing Loans to Total Loan Ratio (NPTL)
1. Debt Equity Ratio (DER)

The extent to which firm uses debt. It measures ability of the bank capital to absorb financial
shocks. In case, creditors default in paying back their loans or the asset values decrease bank
capital provides shield against those loan losses. A bank with lower DER is considered better as
compared to the bank with higher DER. DER is calculated as under:

Total Debt
Debt Equity Ratio =
Shareholders ’ Equity

2. Debt To Total Asset Ratio (DTAR)

It measures the amount of total debt firm used to finance its total assets. It is an indicator of
financial strength of the bank. It provides information about the solvency and the ability of the
firm to obtain additional financing for potentially attractive investment opportunities. Higher
DTAR means bank has financed most of its assets through debt as compared to the equity
financing. Moreover, higher DTAR indicates that bank is involved in more risky business.
DTAR is calculated as under:

Total Debt
Debt To Total Asset Ratio =
Total Assets

3. Equity Multiplier (EM)

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How many times the total assets are of the shareholders’ equity is measure by equity multiplier.
In other words, it indicates the amount of assets per dollar of shareholders’ equity. Higher value
of EM means that bank has used more debt to convert into assets with share capital. Generally,
the higher is the EM the greater is the risk for a bank. EM is calculated as under:

Total Asset
Equity Multiplier =
Total Shareholders ’ Equity

4. Non- Performing Loans to Total Loan Ratio (NPTL)

Nonperforming loans, or NPL, are loans that are no longer producing income for the bank that
owns them. Loans become nonperforming when borrowers stop making payments and the loans
enter default. The exact classification can vary from institution to institution, but a loan is usually
considered to be nonperforming after it has been in default for three consecutive months. Banks
often report their ratio of nonperforming loans to total loans as a measure of the quality of their
outstanding loans. A smaller NPL ratio indicates smaller losses for the bank, while a larger (or
increasing) NPL ratio can mean larger losses for the bank as it writes off bad loans. NPTL is
calculated as under:

Non−performing Loans
Non- Performing Loans to Total Loan Ratio =
Total Loans

D. ACTIVITY RATIOS

The presence of inefficiencies is considered an inherent feature of banking. Banks are regarded
as firms that emerge as a result of some sort of market imperfections; hence they bring about a
certain degree of inefficiency with respect to perfect competitive outcome. Banking efficiency is
important at both macro and micro levels and in order to allocate resources effectively, banks
should be sound and efficient. Efficiency in banking can be distinguished between allocative and
technical efficiency. Allocative efficiency is the extent to which resources are being allocated to
the use with the highest expected value. A firm is technically efficient if it produces a given set
of outputs using the smallest possible amount of inputs. Outputs could be loans or total balance
of deposits, while inputs include labor, capital and other operating costs. A firm is also said to be
cost efficient if it is both allocated and technically efficient Studies on X‐inefficiency, which is a
measure of the loss of allocative and technical efficiency, has been carried out particularly

15
internationally. The results showed that X‐inefficiency is between 20‐30 percent of total banking
costs in the US (Falkena et al 2004)

According to Falkena et al 2004, “the notion of X‐inefficiency suggests that comfortable

incumbents may not produce in the most efficient method. If a few players dominate the market,
they may be sheltered from competitive forces and may use rule‐of‐thumb rather than best
practice methods”. These ratios measure how effectively and efficiently the firm is managing and
controlling its assets. These ratios indicate the overall effectiveness of the firm in utilizing its
assets to generate sales, quality of receivables and how successful the firm is in its collections,
the promptness of payment to suppliers by the firm, effectiveness of the inventory management
practices, and efficiency of firm in controlling its expenses. Higher value of these ratios is taken
as good indicator, which means firm is doing well. Ratios used to measure efficiency of the bank
are Asset Utilization (AU), Income to Expense Ratio (IER), and Operating efficiency (OE) Asset
Utilization (AU)

1. Operating Efficiency (OE)

1. Asset Utilization (AU)

How effectively the bank is utilizing all of its assets is measured by assets utilization ratio. The
bank is presumably said to using its assets effectively in generating total revenues if the AU ratio
is high. If the ratio of AU is low, the bank is not using its assets to their capacity and should
either increase total revenues or dispose of some of the assets (Ross, Westerfield, and Jaffe
2005). Total revenue of the bank is defined as net spread before provision plus all other income.
AU is calculated as under:

Total Revenue
Asset Utilization =
Total Asset

2. Operating Efficiency (OE)

Unlike IER, which measures the amount of income earned per dollar of operating expense, OE is
the ratio that measures the amount of operating expense per dollar of operating revenue. It

16
measures managerial efficiency in generating operating revenues and controlling its operating
expenses. In other words, how efficient is the bank in its operations (Ross, Wedsterfield, and
Jaffe 2005). Lower OE is preferred over higher OE as lower OE indicates that operating
expenses are lower than operating revenues. Operating revenue is defined as net spread earned
before provisions plus fee, brokerage, commission, and for ex income. Other expenses is defined
same as we defined in the previous ratio. OE is calculated as under:

Total Operating Expenses

Operating Efficiency =
Total Operating Revenue

2.3.2.2 Advantage and limitation of ratio analysis

Advantages
 Ratios are easy to compute.
 Ratios provide a standing comparison of a point in time and allow comparisons to make
with industry average.
 Ratios are useful in identifying problem areas of firm.
 Ratio analysis makes an important contribution to the task of evolution a firm’ financial
performance.

Limitation

 The basic data arise from the accounting process and therefore based on historical costs
because one of the main purposes of financial accounting is to match revenues and
expense in the appropriate period there may be little or no direct relationship to the firm’s
cash flows, especially in the short run.
 The accounting processes allow for alternative treatments of numerous transactions thus
two identical firms may report substantially different data by employing alternative
GAAP treatments.
 Window dressing may appear in accounting statements For instance by taking out a long
–term loan before the end of its fiscal year and holding the proceeds as cash a firm could
significantly improve its current and quick ratios, once the fiscal year has ends the firm
could turn around and pay the loan but the transaction has already served its purpose.

17
  Inflation and deflation can have material effects on the firm especially on inventories and
long- term assets, which may be seriously, understand when inflation exists. The
comparability of data within a firm over time and also between firms is therefore limited.
 Industry averages are generally not where the successful firm wants to operate rather it
wants to be the top end of the performance ladder also finding and appropriate industry
for comparison is not as simple as it sounds.
 For firms with substantial international operations other reporting problems exist in
addition to those faced by domestic firms.
 Many firms are multi divisional and sufficient data are generally are not reported so that
outsides can examine the performance of the various divisional Also it is often difficult to
find comparable industry data for multi divisional firms.

2.3.3 Common size analysis

A common size status express each item in the income statement as percentage of net sales and
or express each item in the balance sheet as percentage of total assets since many balance Sheet
ratios are computed as part of the basic financial ratio analysis is usually focused on the
preparation and analysis of common size income statements generally, when items in the
financial statements expressed as percentage of totals assets and total sales, these statements
called common size statements. (Chasten Lanny G. Richard E. Flallery 1995)

2.3.4 Index analysis

Index analysis also called common base year analysis expresses items in the financial statements
as an index relative to the base year. All items in the base year are assuming 100% usually this
analysis is most appropriate for income statements item. In index analyses all items of different
years will be expressed in terms of base selected and prepare common base year statement
standardized financial statements presenting all items relative to certain to base year amount.
(Chasten Lanny G. Richard E. Flallery 1995)

2.4 Classification of financial statement analysis accounts to users

According to users of financial statement analysis the tools and techniques of financial analysis
can be classified as:

18
 2.4.1 External analysis
This performed by outsiders to the firm such as creditors, investors, suppliers, government etc.
All the above users may have their own objective.

2.4.2 Internal analysis

This performed by corporate accounting and finance department for the purpose of planning,
evaluation and controlling operating activities. Here the common users are the management of
organization for a better decision making (Chasten Lanny G. Richard E. Flallery 1995)

2.5 Review of Empirical Studies

There is no scientifically studied literatures in Ethiopia that evaluate the performance of Bank.
Therefore, reviews of various studies were not presented here. But international studies indicate
that banks’ performance differs significantly depending on the reform environment, as well as
the competitive conditions in which they operate.

19
 CHAPTER THREE

3. DISCUSSIONS AND ANALYSIS

3.1 Introduction
This paper focused on the financial statement analysis of three Banks of the year covering 2018.
Under this section the researcher used different ratio analysis in order to determine the financial
strength and weakness of the bank. Then to analyze the data by using trend analysis and the data
is presented in the form of table and also detail discussions and analysis of the study findings are
presented in here is not full filled because in Ethiopia there is no any responsible organization to
determine and to state industry average every factors (dependent and independent) and ratios for
banking industry. The analysis is presented in the following sequence; first the Financial
Highlights of the companies’ followed by the ratios analysis.

3.2 Financial Analysis

3.2.1 Total Income, Total Expenses, and Net Profit

Table 3.1:- Shows Total income, total expenses, and net profit.

ELEMENTS
2018 2018 2018

1,163,551,02 1,494,067,605
Total Income 849,519,458 4

Total Expense 555,544,323 838,505,164 1,115,384,844

Net Profit 293,975,135 325,054,360 378,682,765

3.2.2 Total Deposits and Total Loans & Advances

Table 3.2:-Shows Total deposits and total Loans & advances.

20
 ELEMENT'S

2018 2018 2018

Total Deposits 788,599,624 1,497,948,502 2,177,627,507
Total Loans &
Advances 4,706,574,502 5,165,747,723 7,041,785,113

So, in this case the banks performance is high because the bank can grant loan without any
scarcity.

3.2.3 Interest Income and Interest Expense

Table 3.3:- Interest income and interest expenses.

ELEMENT'S

2018 2018 2018

Interest
Income 517,111,582 763,3438,889 910,745,724
Interest
Expense 156,635,744 763,348,889 910,745,724

3.2.4 Total Assets and Shareholders’ equity

Table 3.4: Total Assets and Shareholders’ Equity

ELEMENT'S

2018 2018 2018

Total Assets 8,828,497,559 11,281,588,879 16,292,906,921

Share Holders 992,923,456 1,317,818,623 1,655,658,622

Equity

21
3.3 Ratio Analysis
As it was already mentioned, a bank’s balance sheet and income statement are valuable
information sources to evaluate financial strengths and weaknesses of a bank and its business
trends. Although the birr amounts found on these statements provide valuable insights into the
financial performance and condition of the bank, the researcher typically use data from them to
develop financial ratios to evaluate the bank financial performance. In all of the remainder of this
chapter, the researcher undertakes key ratios to evaluate different dimensions of financial
performance including liquidity, profitability, efficiency, and credit risk & solvency in each year.
3.3.1 Liquidity Ratios
The liquidity ratios measure the capability of bank to meet its short-term obligations. Generally,
the higher value of this ratio indicates that firm has larger margin safety to cover its short-term
obligations. Among the various liquidity measures, the study uses the following three liquidity
ratios.
3.3.1.1 Loan to Deposit Ratio
Loan to deposit ratio indicates the percentage of the total deposit locked into non-liquid asset or
it used to calculate a lending institution ability to cover withdrawals made by its customers. A
higher loan deposit ratio indicates that a bank takes more financial stress by making excessive
loan. Therefore, lower loan deposit ratio is always favorable than higher loan deposit ratio. This
low value of loan deposit ratio also indicates effectiveness of mediation function of bank.
Loan to Deposit Ratio= Loan / Deposit

Table 3.5:-Loan to Deposit Ratio (LDR)

ELEMENT'S

2018 2018 2018

Total Deposits 788,599,624 1,497,948,502 2,177,627,507
Total Loans &
Advances 4,706,574,502 5,165,747,723 7,041,785,113
Loan to Deposit
Ratio (in %) 596% 334% 323%

22
 3.3.1.2 Cash Ratio (CR)
Another measure of liquidity of the bank is the cash to deposit ratio. The higher the ratio the
better is the liquidity position of the bank, therefore, the more is the confidence and trust of the
depositors in the bank.
Cash Ratio = Cash / Current liability
Table 3.6:- Cash Ratio (CDR)

ELEMENT'S

2018 2018 2018

Cash 1,674,864,006 2,148,247,595 3,319,313,670
Current liability 81,979,825 73,668,445 90,138,987
Cash Ratio
0.04 0.04 0.03
5% 4% 3%

3.3.1.3 Loan to Asset Ratio (LAR)

The loans to assets ratio measure the total loans outstanding as a percentage of total assets. The
higher this ratio indicates a bank is loaned up and its liquidity is low. The higher the ratio, the
more risky a bank may be to higher defaults.
Loan to Asset Ratio = Loan / Asset

Table 3.7:-Loan to Asset Ratio (LAR)

ELEMENT'S

2018 2018 2018

Total Loans & 4,706,574,50
Advances 2 5,165,747,723 7,041,785,113
16,292,906,921
Total Assets 8,828,497,559 11,281,588,879
Loan to Asset Ratio
(LAR) 0.533 0.457 0.432
53.3% 45.7% 43.2%

3.3.2.1 Return on Assets (ROA)

ROA is defined as the ratio of profit after tax to total asset. It reflects the efficiency with which
banks deploy their assets. The higher the ROA, the most profitable is the bank.

23
Return On Asset = Net Profit After Tax / Total Asset
Table 3.8:-Return on Assets (ROA)

ELEMENT'S

  2018 2018 2018

221,796,710 248,316,900 290,203,745
Net Income
16,292,906,921
Total Assets 8,828,497,559 11,281,588,879
Return on Asset
(ROA) 2.51 % 2.2% 1.7%
3.3.2.2 Return on Equity (ROE)
This ratio indicates how bank can generate profit with the money shareholders have invested.
The higher value of this ratio shows higher financial performance. Like ROA, this ratio is also
indicator for managerial efficiency.
Return On Equity = Net Profit After Tax / Shareholders’ Equity

Table 3.9:-Return on Equity (ROE)

ELEMENT'S

2018 2018 2018

290,203,745
Net Income 221,796,710 248,316,900
Share Holders
Equity 992,923,465 1,317,818,628 1,665,658,622
Return on
Equity(ROE) In % 22.3% 18.8% 17.4%

3.3.2.3 Profit Expense Ratio (PER)

This ratio indicates profitability of the firm with regard to its total expenses. A high value of this
ratio indicates that bank could make high profit with a given expenses.

Profit to Expense Ratio = profit before tax / Operating Expense

Table 3.10:-Profit Expense Ratio (PER)

24
 ELEMENT'S

2018 2018 2018

378,682,761
Profit before tax 293,975,135 325,045,860
140,728,635 838,505,164 1,115,384,844
Operating Expense
Profit Expense Ratio
(PER) 2.02 0.38 0.32
.
3.3.2.4 Return on Deposit (ROD)
This ratio shows percentage return on each dollar of customers’ deposit. In the other words, it
indicates the effectiveness of bank in converting deposit into net earnings.
Return on Deposit = Net Profit After tax / Total Deposit

Table 3.11:- Return on Deposit (ROD)

ELEMENT'S

2018 2018 2018

290,203,745
Net profit after tax 221,796,710 248,316,900
Total Deposits 788,599,624 1,497,948,502 2,177,627,507
Return on Deposit
(ROD)In % 2.81% 16.5% 13.3%
3.3.2.5 Income to expense Ratio (IER)
Income to expense is the ratio that measures amount of income earned per dollar of operating
expense. This is the most commonly and widely used ratio in the banking sector to assess the
managerial efficiency in generating total income relative controlling its operating expenses. High
IER is preferred over lower one as this indicates the ability and efficiency of the bank in
generating more total income in comparison to its total operating expenses.
Income to expense Ratio = Total income / Total Operating Expenses

Table 3.12:- Income to Expense Ratio (IER)

ELEMENT'S

25
 2018 2018 2018
Operating Income 849,519,458 1,163,551,024 1,494,067,605

Total operating
555,544,323 838,505,164 1,115,384,844
expense
Income to Expense 1.52 1.38 1.33
Ratio (IER)

3.3.3 Leverage Ratio

The risk and solvency ratios measure the extent to which a firm relies on debt financing rather
than equity financing. These ratios are also referred to as gearing, debt, or financial leverage
ratios. These ratios determine the probability that the firm default on its debt contacts. The more
the debt a firm has the higher is the chance that firm will become unable to fulfill its contractual
obligations. The following ratios measure for risk and solvency were used for the study.
3.3.3.1 Debt to Equity Ratio (DER)
This ratio indicates the proportion of assets financed with debt. A high value of this ratio
provides indication that firm involves in more risky business.
Debt to Equity Ratio = Total Debt / Shareholders’ Equity
Table 3.13:- Debt to Equity Ratio (DER)

ELEMENT'S

  2018 2018 2018

Total Liabilities 7,825,574,094 9,963,770,250 14,627,248,299
Share Holders Equity 992,923,465 1,317,818,628 1,665,658,622
Debt to Equity
Ratio (DER) 7.88 7.56 8.78

3.3.3.2 Debt to Total Assets Ratio (DTAR)

DTAR measures ability of the bank capital to absorb financial shocks. This ratio indicates the
proportion of assets financed with debt. A high value of this ratio provides indication that firm
involves in more risky business.
Debt to Total Assets Ratio = Total Debt / Total Assets
Table 3.14:- Debt to Total Assets Ratio (DTAR)

26
 ELEMENT'S

  2018 2018 2018

Total 7,825,574,094 9,963,770,250
Liabilities 14,627,248,299
Total Assets 8,828,497,559 11,281,588,879 16,292,906,921

Debt to Total
Assets Ratio 88.6 88.3
(DTAR)% % % 89.7%

3.3.3.3 Equity Multiplier (EM)

This ratio shows how many dollars of assets must be supported by each dollars of equity capital.
The higher value of this ratio indicates signal for risk failure.
Equity Multiplier = Total Asset / Total Shareholders’ Equity

Table 3.15:- Equity Multiplier (EM)

ELEMENT'S

  2018 2018 2018

Total Assets 16,292,906,921
8,828,497,559 11,281,588,879
Share Holders
Equity 992,923,465 1,317,818,628 1,665,658,622
Equity Multiplier
(EM) 8.89 8.46 8.56

3.3.3.4 Non Performing Loans to Total Loan Ratio (NPTL)

NPTL ratio is one of the most important criteria to assess the quality of loans or asset of the
Bank. It measures the percentage of gross loans which are doubtful in banks’ portfolio. The
lower the ratio of NPTL, the better is the asset/credit performance for banks.
Non-Performing Loans to Total Loan Ratio = None-Performing Loans / Total Loans

27
Table 3.16:- Non Performing Loans to Total Loan Ratio (NPTL)

ELEMENT'S

2018 2018 2018

Doubtful Loans and
54,437,566 92,591,935 113,756,883
advance
Total Loans &
4,706,574,502 5,165,747,723
Advances 7,041,785,113
Non-performing 0.011% 0.017% 0.016%
Loans to Total Loan
Ratio (NPTL)

3.3.4 Activity Ratios

These ratios measure how effectively and efficiently the firm is managing and controlling its
assets. A firm is technically efficient if it produces a given set of outputs using the smallest
possible amount of inputs (Falkena et al, 2004). Outputs could be loans or total balance of
deposits, while inputs include labour, capital and other operating costs. Ratios used to measure
efficiency of the Asset Utilization (AU), Income to Expense Ratio (IER), and Operating
efficiency (OE).
3.3.4.1 Operating Efficiency (OE)
Operating efficiency is the ratio that measures the amount of operating expense per dollar of
operating revenue. It measures managerial efficiency in generating operating revenues and
controlling its operating expenses. In other words, how efficient is the bank in its operations.
Lower OE is preferred over higher OE as lower OE indicates that operating expenses are lower
than operating revenues.
Operating Efficiency = Total Operating Expenses / Total Operating Revenue

Table 3.17:- Operating Efficiency (OE)

28
 ELEMENT'S

2018 2018 2018

Total operating expense 555,544,323 838,505,104 1,115,384,844
Operating Income 849,519,458 1,163,551,024 1,494,067,605
Operating Efficiency (OE) 65.3% 72% 74.6%

3.3.5 Marketability Value Ratio

3.3.5.1 Earnings per Share (EPS)
Earnings per share (EPS) ratio measures how much net income has been earned by each share of
common stock. It is computed by dividing net income less preferred dividend by the number of
shares of common stock outstanding during the period.
There is no rule of thumb to interpret earnings per share. The higher the EPS figure, the better it
is. A higher EPS is the sign of higher earnings, strong financial position and, therefore, a reliable
bank to invest money.
Table 3:19 Banks’ annual earnings per share
Net Income – dividend of preferred stock holder
Earnings per Share = Number of common stock outstanding
Table 3.19: shows Earning per share (EPS)
ELEMENT'S

2015 2016 2017

Earnings per share 315.46 261.13 241.91

29
 CHAPTER FOUR

4. CONCLUSIONS AND RECOMMENDATIONS

In chapter three, the actual performance of the companies has evaluated. Here are the researcher
conclusions and recommendations based on the analysis of the previous chapter.

4.1 Conclusions
From the brief explanation and illustrations of 2018, financial statements of Companies have
been used to analyze the financial performance and their trend for the year under study. We
faced difficulties to draw some conclusions, we searched for a solution such as to find a country
with the same banking industry level, but we can’t. So, we just grossly draw the conclusions
according to our theoretical literature review and the state of Ethiopian’s banking industry.
Some of the conclusions of the study include the following:
 In Ethiopia there is no any responsible organization to determine and to state industry
average on every factors (dependent and independent) and ratios for banking industry.
 The liquidity ratios measure of the banks to meet its short-term obligations. Generally,
the study indicates that firms have a small margin safety to cover their short-term
obligations, but according to international banking system it is very poor.
 The activity ratios which measures the effectiveness and efficiency of the firms to
manage and control its assets, is technically efficient.

30
4.2 Recommendations
The following recommendations, based on the above research findings, are forwarded below in
order to enhance the financial performance of the companies in the banking industry:
 We recommended that, the banking industry should have a supportive a big organization
which determines the factors and the ratios monthly.
 The banking industry in Ethiopia should increase its capital as much as their liquidity
ratios
 Indicate a safe margin, these will have achieved through different methods, but the
management should decide through further studies which include every situation, factors
and its environment.
 The effectiveness and efficiency of the firms through management in the banking
industry seems enough some services, but it is poor in credit creation.

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James Mort, 1997, Financial Management, 7th edition

Donald E. Kieso, 1998, Intermediate accounting, volume 2, 9th edition

Ross Levine, 2005, Finance and Growth: theory and Evidence, volume 1A

Needless Belverd E., 1998, Principles of Financial Accounting,

Pollard Meg, mills sherry T., Harrison Walter T, 2007, principles of accounting

Steven A.Ross, Randolph W. Westerfield, Jeffrey F. Jaffe, Gordon S. Roberts, 2005, Corporate
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32