THE ROLE OF FINANCIAL RATIOS ON BUSINESS DECISIONS: CASE STUDY OF LISTED BANKS ON THE NIGERIAN STOCK EXCHANGE

THE ROLE OF FINANCIAL RATIOS ON BUSINESS DECISIONS: CASE STUDY OF LISTED BANKS ON THE NIGERIAN STOCK EXCHANGE

ABSTRACT

This study seeks to determine the role of financial ratios on business decisions of money deposit banks listed on the Nigeria Stock Exchange (NSE) from 2005-2013. There were three ratios used which were selected based on CAMEL ratio. Capital adequacy ratio was the dependent variable. The explanatory variables are liquidity ratio and profitability ratio. Liquidity ratio includes; cash & cash equivalent/ Total Liabilities, Loan and Advances/Total Assets, Loan and Advances/ Total Deposits while profitability ratio includes; Return on Assets, Return on Equity and Net interest income / Loan and Advances. Descriptive methodology, correlation and regression analysis were applied to data obtained from the financial statement of the banks using the Statistical Package for Social Student (SPSS). The result showed a weak and negative relationship among when ratios are considered in isolation but a strong relationship was exhibited when all the ratios were analysed in aggregate. The studies thus conclude that financial ratios can be useful for business decision making when other intervening factors are incorporated.

CHAPTER ONE

INTRODUCTION

1.1 BACKGROUND INFORMATION

Accounting is a systematic process of identifying, recording, measuring, classifying, verifying, summarizing, interpreting and communicating of financial information in order to enhanced informed judgement and economic decision by users of the account. This can be making possible when the financial information is made available to the users. American Accounting Association (AAA) defined accounting as “the process of identifying, measuring and communicating economic information to permit informed judgments and decisions by the user of information”. Financial information can be derived from the financial statement. The standard practice for businesses is for them to present their financial statements which adhere to regulatory framework and conceptual framework established in order to ensure uniformity of information and presentation across international borders. The financial statements comprise collection of reports about an organisation’s financial result and condition which is presented in a clear and concise manner as it contains useful financial information that is hidden in figures. Its major components are; Statement of Financial Position, Statement of Cash Flow, Statement of in Equity, Statement of Profit or Loss and Other Comprehensive Income and Notes to the Accounts.

Financial ratios are applied on items reported in the financial statements with the intention to derive the effective economic decision for the following reasons:

 Determining the ability of a business to generate cash, and the source and uses of the cash;

 Ascertaining whether a business has the capability to payback its debt;

 Evaluating the financial results on a trend line in order to spot any looming profitability issues;

 Adopting financial ratio that can indicate the condition of a business; and

 Investigating the details of certain business transactions, as outlined in the disclosures that accompany the statement;

The quantitative analysis of financial statement prepared and presented by an entity to drive useful information can be bewildering and intimidating to many users. Business decisions making requires timely and relevant financial information as observed by Bittle,Burke&Lafarge (1984).Bittle et al further noted that “managers want information because they need to make decisions. Proper use of information is thus arguably an information part of decision making and financial ratio is one of the key elements in the fundamental analysis since standard ratio can be employed to evaluate the overall financial condition of a corporation or other organisation. The financial analysis as a tool for accounting helps us to determine an entity’s strength and weakness using ratios from the financial data. Such analysis can be a comparison of the company’s own historical performance or that of other companies focusing on the Income Statement, Statement of Financial Position, and Statement of Cash flow statement. One key area of financial analysis involves extrapolating the company’s past performance into estimate of the company’s future performance.

Ratios are highly important profit tools in financial analysis which helps financial analysts in implementing plans that improves company’s profitability, liquidity, financial structure, reordering, leverage, and interest coverage. Igben (1999) noted that financial ratio is a proportion or fraction or percentage expressing the relationship between one item in a set of financial statements and another item in the financial statements. Muresan&Wolitzer (2004) 3

posit that financial ratio analysis is a useful measure to provide a snapshot of a firm’s financial position at any particular moment of time or to provide a comprehensive idea about the financial performance of the company over a given period of time. It can thus be argued that any successful business owner need to constantly evaluate the performance of his or her company, comparing it with the company’s historical figures, with its industry competitors, and even with successful businesses from other industries. Although in analysing and interpreting financial statement the use of financial reporting is the main aspect in decision making. According to Gibson (1989), financial reporting is not an end in its self but it is intended to provide information that is useful in making business and economic decision. Aborode (2006) posited that financial statement need to be interpreted for better understanding and analysis by using individual items contained in financial statement and/or ratios computed from items contained in financial statement. In addition, ratio analysis involves taking items from the financial statement and forming ratio with them, to enhance informed business decision and judgement. A business is described as an economic system where goods and services are exchanged for money, a business could be privately or state owned which requires some form of investments and enough customers to whom its output can be sold on a consistent basis in order to make profit. Business decision is a logical process of selecting from choice of available options for profit, since the primary objective of a business is profit maximisation. Decision making is an act of choosing between two or more course of actions. MCShane&Glinow (2000) defined decision-making as “a conscious process of making choices among one or more alternatives with the intention of moving toward some desired state of affairs. Business decision making is thus a necessary criterion for sustainability and profitability of any business concern. Financial ratios are considered as a major tool for business decisions which will assist both internal and external users of financial statements to give informed judgement about the past, present and future potentials of the company.

This study is focused on money deposit banks listed on the floor of Nigerian Stock Exchange and how decisions are taken by their various diversified interest. Banking sector is referred to as the financial sector that continually takes important roles in the effort to achieve socio- economic development. It is believed that, financial sector could be a catalyst of economic growth if it is adequately supervised, controlled and monitored. The money deposit banks serve as important financial intermediaries to the public in any economy, as they represents a nation’s financial regulator which needs to be supervised because it determines the scope and economic development of a country. Hence, activities of financial regulations, banking supervision serve as an equilibrium position where law and economic meet. The problem of business failure is particularly interesting from the perspective of the banks. This is because financial crisis has had significant and dramatic consequences for the world economy as it results in economic downturn. The study therefore seeks to know the level of efficiency in the use of asset by Nigerian money deposit banks, their liquidity stance which measures their ability to meet evolving current obligations as they fall due and also determine the adequacy of their retained earnings. The choice of listed money deposit banks in Nigeria as case study for the research is based on the diversified interest involved and how the various interests can make informed decisions and judgement from the financial information reported. Diversified interest include the investors, management, regulatory (i.e. CBN, NDIC, NSE, SEC), trade payables and depositors etc.

1.1.1HISTORICAL DEVELOPMENT OF BANKING SYSTEM IN NIGERIA

The Nigerian banking industry is regulated by the Central Bank of Nigeria. It is made up of deposit money banks, development finance institutions, micro-finance banks, finance companies, bureau de changes, discount houses and primary mortgage institutions. The historical development of banking system in Nigeria can be dated back to the era of colonisation which started operation and became effective between 1892 to 1894.The African Banking Corporation and First Bank of Nigeria which was formerly known as the Bank of British West Africa (BBWA) was the standard and first bank alongside with other colonial banks that influenced our commercial operation, financial activities and also foreign exchange. There was a merger in 1952 which facilitated Nigeria Barclays Banks into commercial operation as well as the British and French Bank for commerce and industry. The French bank was later known as the United Bank of Africa in 1925.All the banks listed above were all governed and controlled by colonial masters but were not aimed at meeting the need of Africans. As a result of this, Nnamidi Azikiwe in 1929 established the ACB (African Continental Bank) which was the first indigenous bank but was not the first bank in Nigeria. The bank was known for industrial and commercial purpose but it went into liquidation 15 months later in 1930 due to embezzlement, mismanagement and accounting incompetence coupled with economic repression prevalent in that period. In 1947, the ACB was established and known as Pan Africanism. More banks were subsequently created which were; Agbonmagbe bank in1945, the merchant bank in 1952, a separate trading company was prominent during this period which was offering trade credit to customers. Other non- bank financial intermediaries were; post office saving banks, Lagos Building Society( known as Federal Mortgage Bank of Nigeria), Federal and Regional Loan Institutions. However, banking legislation never existed until 1952. In 1952, the submitted result of enquiry made by Mr. G D Paton led to the enactment of Bank Ordinance Act of 1952 which brought about setting of standards, required reserve fund, established bank examinations and provided assistance to indigenous banks. As at then there were three (3) foreign banks namely; the Bank of British West Africa, Barclays Bank and the British and French bank and two (2) indigenous banks - National Bank of Nigeria and The Africa Continental Bank. The ordinance was preventing undercapitalised banks from operating but was unable to check the malpractice of banks and inability to develop the banking system. It could also not provide a reserve force and lender of last resort which is referred to as a place where banks fall to during liquidity crisis for indigenous banks.

The motion for the establishment of Central Bank of Nigeria was presented March, 1958 and was fully implemented on1stJuly 1959. The CBN was charged with the functions of promotion and development of the financial market, bankers’ bank, currency issue and distribution, promotion of special schemes and funds for industrial development, supervision of finance houses etc. therefore we can say that from 1892 to 1952 was referred to as a free banking era because of the absence of banking regulation as regarding setting up of bank. In 1988, the government established Nigeria Deposit Insurance Corporation (NDIC) with the responsibility of carrying out some sort of financial reforms and assisting the Central Bank of Nigeria in formulation of policies. It was charged with the responsibility of ensuring safe and sound banking services and insuring bank deposits through effective supervision. It was the basis of its assistant supervisory role with the Central Bank that the NDIC Act was useful. The Banks and Other Financial Institutions Act (BOFIA) No 25 of 1991 vests the CBN with the sole authority of licensing banks, determining their maximum capital requirements and sanctioning of any bank which failed to comply with the provisions of the Act. The Nigerian Banking industry has undergone various reforms including the consolidation which has brought great transformation to the banking operations in Nigeria. This consequently led to licensing twenty five (25) commercial banks. Further reforms introduced by Sanusi led administration has resulted in only eighteen (18) commercial banks and three (3) bridged banks.

1.2 STATEMENT OF THE PROBLEM

Business decision is arguable an integral part of any viable organisation. Business decisions are taken in order to develop investment, financial and dividend policy. The use of financial ratio has been proven to aid companies in making informed judgement due to the comparative nature of ratios towards achieving its profit maximisation objectives. Decisions are constantly made by both internal and external users of financial information. Nigeria money deposit banks listed on the floor of Nigerian Stock Exchange are considered as case study due to the diversified interests making use of the financial information published by bank. Banks prepare and publish their financial statement but most users cannot interpret the financial information contained in it. This is because proper interpretation of published financial data require analytical tool such as financial ratio. How effective and efficient is the use of financial ratios for decision making by stakeholders of these banks? How do users of financial information in different environment use the financial ratio for comparison in business decisions?

Also, given the historical basis for the preparation and presentation of financial statement, it is generally argued whether the financial data can provide a basis for prediction in making business decision. This research seek to address specifically how depositors and top management among other stakeholders can make effective decision using financial ratio as tool.

1.2 OBJECTIVES OF STUDY

The broad objective of the study is to examine the role of financial ratio analysis in business decision with specific focus on listed commercial banks as case study. The specific objectives are to:

i. Ascertain the comparability of financial ratio for business decisions in Nigerian banks

ii. Evaluate the level of understanding of applicability of ratio analysis to banks financial statements for decision making

iii. Determine the usefulness of financial ratio in measuring and predicting of the financial position for business decisions in Nigerian money deposit banks

iv. Access how financial ratio could aid business decision

TOPIC: THE ROLE OF FINANCIAL RATIOS ON BUSINESS DECISIONS: CASE STUDY OF LISTED BANKS ON THE NIGERIAN STOCK EXCHANGE

Format: MS Word

Chapters: 1 - 5
Delivery: Email

Number of Pages: 68

Price: 3000 NGN

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