RATION ANALYSIS AS A BANK LENDING TOOL
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RATION ANALYSIS AS A BANK LENDING TOOL
In order to address the barriers to achieving sound lending, which contribute significantly to the non-recovery of loans, this study aims to examine the bank lending activities in Nigerian banks. determining the degree to which ratio analysis aids bank management in making loan decisions.
Simply put, bank lending is the process of determining if a proposition is bankable with the aim of giving credit facilities on terms and conditions that are agreeable to the lender and borrower.
The goal of achieving social and economic goals for society while making money for the banks is supposedly the justification for bank lending.
A shift from an era of paper gains to an era of losses has occurred throughout time. In actuality, many banks no longer extend credit to late-paying debtors.
All of these topics, as well as many more, are covered in this project since one of the most crucial roles of ratio analysis is to help financial managers increase efficiency by providing pertinent financial data.
Research questions were employed in the analysis that was developed to carry out the aforementioned functions. On the data gathered, pertinent tables were created, and percentages were utilised to analyse the data.
The replies were used to test the hypothesis that “RATIO ANALYSIS does not help financial managers or serve as a lending too” and it was determined to be false.
Based on the findings, some recommendations were made that, if followed, would significantly improve the efficiency and dependability of employing ratio analysis to assess a given institution’s financial performance over a specific time period before lending.
RATION ANALYSIS PROPOSAL AS A BANK LENDING TOOL
This project’s first chapter aims to explain how bank lending relates to the provision of money for needy customers in the form of loans from savings of the fund surplus units paid into the bank.
This is the foundation of a bank, and ratio analysis should be done with extreme caution because bank lending is acceptable to both lenders and borrowers.
In this chapter two, the notion of bank lending refers to the process of extending loans to borrowers. It is a crucial aspect of commercial banking.
Banks have some lending goals, but they won’t entirely distance themselves from them once they’ve identified the issues and their effects on the appraisal of the borrower’s financial situation.
In chapter three, study methodology and design using an experimental survey method based on official interviews will be discussed. These will be interpreted in their entirety.
In chapter four, data will be presented and findings will be analysed. Questionnaires will be used as a research tool.
Chapter 5 provides summaries of some of the research’s important findings as they relate to the study’s principal goal, suggestion, and conclusion.
RATIONAL ANALYSIS AS A BANK LENDING TOOL: CHAPTER ONE
Introduction, section 1.0
1.1 BACKGROUND OF THE STUDY
Bank lending is involved with providing money for loans from savings of the fund surplus units paid into the bank to customers in need.
The known fact that the saved fund is at the bank’s disposal for a predetermined duration allows the bank to give these funds to clients who may need them more immediately.
One of the most common services offered by banks is lending, which is motivated by the need to achieve some economic growth through the expansion of already existing firms and the establishment of new businesses for profit. It serves as the foundation for a bank. As a result, this activity requires a lot of caution.
There are lending guidelines that should be followed and inquiries that should be made regarding:
(A) To whom is the bank loaning money?
(b) How trustworthy is this client?
(c) How well-known is this particular customer at the moment?
(d) How much money may a bank loan to a client at once?
The ability of a bank to make sound lending decisions is really put to the test, thus the bank should be very interested in the health of the company as a whole, not just its customers.
Loans that are not repaid cause banks to incur significant losses. Before making a loan, banks should thoroughly analyse and evaluate the financial statements.
This study entails evaluating a firm’s or borrower’s past, current, and predicted future financial position to identify any weaknesses that the company or borrower may be able to take advantage of.
Financial ratios are the tools for the study of financial statements and can be used to provide vital information about the health of a business or its clients.
The following are such crucial inquiries:
(A) How liquid is the corporation overall?
(b) Is management making enough money with the company’s resources?
(c) How does the management of the company fund its investments?
Ratio analysis is the solution to these queries in a nutshell.
Ratio is characterised as a valuable tool for analysing a set of financial accounts, according to UBAKA (1996). For analysing a set of financial statements, it is the only such instrument available to accountants. The mathematical link between two figures in a set of financial statements is known as a ratio.
It can be delivered in a variety of ways. Any relationship being investigated will be presented in a specific way that the analyst can best interpret; for example, some people prefer to look at the periods, while others prefer percentage presentations.
The three fundamental financial statements that serve as the foundation upon which financial ratios are often constructed for analysis are as follows:
(a) A balance sheet, which is a snapshot of a company’s current financial situation, including its assets, liabilities, and owner’s equity.
(a) The profit and loss statement, also known as the income statement, gives an overview of the net profit generated by the business’ operations over a given time period. It is calculated using an accrual basis as opposed to a cash approach.
(c) The statement of charges in financial position, sometimes referred to as the sources and use of adds statement, gives an accounting of the sources that were made available during a given time period and the purposes for which they were used.
Low arithmetic ability is needed to analyse the aforementioned financial statements using financial ratios. Higher layers of management, who are in charge of maximising profits and making long-term plans, are the main users of ratios.
To evaluate the data borne in financial analysis as to provide information about an organisation and such information do not be restricted to accounting data, one must grasp the inner workings of the financial ratios and the importance of various financial relationships.
Ratios based on historical performance may be useful in estimating an establishment’s future earning potential and financial projections. We need to be aware of the various restrictions placed on such data.
Before granting a loan, we must look beyond the financial statement and consider the nature of the organisation, its place within the economy,
its activities, its research expenditures, and, most importantly, the quality of its engagement (MATHER 1979). Four different sorts of financial ratios are used to examine a company’s financial situation. As follows:
1. Liquidity ratios: These ratios show how well a company can satisfy its immediate obligations. Liquidity ratios gauge a company’s capacity to meet immediate obligations with its liquid assets.
Liquid assets comprise accounts receivable and other debts owing to the firm that will create cash when those debts are paid when they are due, which is of particular significance to the firm’s short-term creditors.
Cash and other assets such as marketable securities and inventories are also included because they can both be sold to raise money to pay off upcoming short-term obligations.
The current and quick ratios are two different types of liquidity ratios.
(a) Current Ratio: The current ratio is the most straightforward indicator of a company’s capacity to raise capital to pay short-term obligations.
The current asset to current liability ratio is what determines this. Current assets are thought to be reasonably liquid, which implies they can produce cash in a reasonably short amount of time.
If the current ratio is too low, as short-term commitments mature, the company can struggle to meet them. If it is excessively high, the company might be investing too much on current assets.
The component(s) of current assets that are excessively large should be lowered in order to lower the current ratio. The money saved should then be invested in longer-term, higher-yielding assets, used to pay down debt, or distributed as dividends to the company’s owners.
Current Asset is equal to the current ratio.
Existing Liability
(b) Quick or acid test ratio: Determines how well the company can satisfy short-term obligations using its most liquid assets.
Since inventory is typically far less liquid than other current assets omitting inventory dividend by current obligations, it is not included in this calculation of current assets. Thus:
Current Assets – Inventory or Stock = Quick Ratio
Existing Liability
2. Leverage Ratios: Calculate how much total debt the company is carrying. They demonstrate the company’s capacity to pay off both short-term and long-term debt.
These ratios are calculated either by comparing the income statement’s fixed charges and earnings or the balance sheet’s debt and equity elements.
The ability of the company’s revenue to sustain interest and other fixed costs, as well as whether there are enough assets to pay off debt in the event of liquidation, are reflected in these leverage ratios, which are significant to creditors.
Since interest costs are a business expense that rises as debt levels do, shareholders are also worried about these ratios. If borrowing and interest costs are too high, the company may potentially go bankrupt.
There are three different types of leverage ratios.
Total debt divided by total assets is the debt-to-total assets ratio. As a result, total debt (liabilities) equals the debt to total asset ratio.
Overall Assets
In general, creditors prefer a low debt ratio since it suggests more security of their position. This ratio is sometimes known simply as a debt ratio. A larger debt ratio typically entails a higher yield on the company’s borrowing; after a certain point, the company will be unable to borrow at all.
Ratio of Interest Earned to Times
according to interest
equals Earnings Before Interest and Taxes as a result.
(EBIT) Consequently, EBIT
rates of interest
This ratio shows how easily the company may use its profits to pay the debt’s yearly interest. Since Earnings Before Interest and Taxes (EBIT) more than adequately covers interest in this case, creditors are very sure that the debt interest will be paid.
3. The ratio of income available to cover fixed expenses divided by such expenses is known as the fixed charges coverage ratio. All fixed naira expenses, such as lease payments, sinking fund contributions, and interest on debt, are included in fixed charges.
A fixed fee is a cash outflow that the company cannot prevent without going against the terms of its contracts. The company makes regular contributions into a sinking fund, which is eventually used to settle the long-term debt for which it was established fixed charges coverage.
Amount of money available to cover fixed costs
Fixed costs
Specifically, operating income plus leasing payment and additional earnings.
Interest plus lease payment plus contribution to sinking fund before taxes
The fixed charges coverage ratio shows how much money is available to cover all fixed expenses.
4. Activity Ratios: Show how efficiently a company generates sales using all of its assets. The firm’s investments in short-term and long-term assets are either too little or too high, depending on these ratios.
If there is an excessive amount of investment in an asset, it may be best to use the money invested there for more direct and productive uses.
Additionally, if the investment is too minimal, the company can offer subpar customer service or produce goods inefficiently. The following fall under the category of activity ratio:
(a) A big stockout is implied by inventory turnover, which is equal to cost of items sold divided by average inventory turnover. When compared to the amount required to service sales, a low inventory turnover indicates a substantial investment in stocks.
Unproductive resource ties are caused by excess inventory. On the other side, if inventory turnover is too high, stocks are too little, and it’s possible that the business is frequently out of stock (running low on inventory),
which results in lost business. The goal of this ratio is to keep inventory levels in relation to sales at a level that is neither excessive nor insufficient to satisfy consumer needs.
(a) Average collection period: This is a measurement of the amount of time it takes from the point of sale to the point where the customer gets paid.
This percentage shows how effectively the company collects from its sales. It might also represent the company’s credit guidelines. The faster the company receives the money due to sales, the faster it can invest it to earn interest.
(c) Fixed Assets Turnover: This reveals how effectively the company’s assets are leveraged to produce sales. This demonstrates how well the firm’s fixed assets are being utilised.
A low ratio suggests excessive planning and equipment expenditure in comparison to the value of the output being produced.
(d) Total Assets Turnover: This measures how effectively the company’s assets are employed to produce sales. If it is low, excessive fixed asset investment is being made (James and Horne 1989).
(e) Profitability Ratios: These ratios assess how successfully a company ensures a net return on investment or sales. Under the umbrella of profitability ratios we have, poor performance shows a fundamental failing that,
if not remedied over an extended period of time, would likely result in the firm going out of business because profit is the ultimate goal of a corporation:
The greatest metric for gauging a company’s achievement of its objectives is return on equity (ROE). The primary goal of management is to maximise shareholder returns on the company.
By carefully analysing financial statements and using them to evaluate a borrower’s loan application before lending, the flaws with bank lending would have been exposed at the conclusion of this effort, along with a solution for effective and efficient bank lending.
1.2 STATEMENT OF THE PROBLEMS:
Because of the danger, banks are hesitant to lend to customers. Even while bank lending is necessary, because of the issues it is linked to, it is viewed as risky. Since the issue of unpaid loans is a criticism of banks’ judgement, each bank is required to use an examination of the borrower’s financial statement at a specific time.
Poor lending practises, which might result from inadequate evaluation of the borrower’s financial statements, are typical of most banks.
As a result, the banks frequently fail to recognise that there is no straightforward method of evaluating the borrower’s financial situation prior to loan since they share the widespread consumer perception that the fact that the customer is earning a profit is an open door to the heart of the treasury.
It is important to ensure that the funds needed for repayment will be accessible when needed when engaging in lending operations. Therefore, the fundamental issue is the banks’ failure to reclaim their potential loans.
1.3 OBJECTIVES OF THE STUDY:
Ratio has been defined as a technique that may be used to simplify significant figure comparison and express the relationship as a percentage,
allowing the borrower’s accounts to be understood by highlighting key elements therein (Spice and Peglers’ 1971). This study is focused on analysing service functions offered to lenders (financial institutions). Therefore, the goals were as follows:
i. to ascertain the role that ratio analysis plays in lending for financial institutions. To better understand how ratio analysis is used by commercial banks and other institutional lenders as a key instrument for lending.
ii. to determine whether ratio analysis is genuinely useful for bank managers in assessing a borrower’s financial performance.
iii. to investigate ratio analysis, learn about its significance, and discover how bank managers might use it to make loan decisions.
iv. to demonstrate how a rigorous examination, analysis, and use of financial ratios can assist a lender in learning all there is to know about a borrower’s finances and facilitate lending.
1.4 THE SIGNIFICANCE OF THE STUDY:
The relevance of the research is to highlight these issues and their impact on the lender’s view of the borrower’s financial situation in light of the concerns that the study logically links to.
In this study, efforts will be made to look into the issue areas where managerial and other shortcomings have contributed to the steadily increasing default in the steady loan repayment schedule by the peasant borrowers.
This institutional arrangement is designed to promote economic and individual growth through loan advancement.
The research project is crucial since it primarily entails an empirical investigation into the banks’ inadequate lending operations. When the study is finished, it will reveal the techniques used by banks and other lenders to evaluate clients before giving credit.
The study will also make a suggestion for an active and effective lending method that uses financial statement analysis, interpretation, and use to help with the loan process.
This method will be helpful to banks and other institutional lenders. It is also significant since it will give lenders (Banks) the chance to reevaluate their lending judgements; a poor judgement will result in a negative lending decision.
Additionally, the research project aims to highlight the grave issues related to peasant defaults on consumer loans. It will also look at how it affects the Nigerian economy.
The author argues that if the straightforward advice from the in-depth study is strictly followed, it will assist to restore normalcy and sanity in the way that the borrower’s financial situation should be reviewed by the financial lender before issuing credit advances.
1.5 SCOPE AND LIMITATIONS OF THE STUDY
The goal of the research project is to examine the financial ratios that financial lenders and other institutionalised lenders will use to evaluate the borrower’s financial situation prior to issuing credit advances.
Everybody knows that a lender’s ability to make a sound loan depends on being informed about the borrower’s financial situation and performance before issuing the negotiated credit extensions. The research project is also intended to explore all of the fundamental ideas behind responsible lending.
This research work does not ignore the limitations of bank lending that result in default in repayment of the advances given. Once more, the researcher went above and beyond to determine the goals of this ratio analysis (if any) and the roles they play in the lenders’ decision-making regarding the extension of loans in order to achieve sound lending.
PROBLEMS WITH THE STUDY:
The research project is planned to include a certain sample. Again, the Union Bank of Nigeria Plc, Ogui Road Branch, Enugu was picked as the commercial bank for the country to facilitate the collecting of data.
Due to the nation’s economic situation, including the high cost of transportation, the researcher faced numerous challenges when gathering the data.
This was due to the significant increase in the overall price of goods, particularly the severe gasoline shortage that limited my movement.
Consequently, it was challenging to obtain a variety of information from the bank’s workers due to the nature of banking, which requires concealment. However, the focus of the study was on UNION BANK OF NIGERIA PLC, ENUGU, a single financial institution.
Starting with the obvious problems mentioned by the researcher which affected wider average for data collection, there were persistent lock-outs and some industrial disharmony among the agitating workers of various departments of the institution at that particular period,
the researcher has chosen to further limit the study to a particular branch of the institution located at Ogui Road, Enugu.
The unpleasant situation led to nonchalance and the mistaken belief that the bank executives would be punished if they answered questions from outsiders and conducted interviews with them.
Despite the above, the researcher had to put aside some essential personal requirements in order to fulfil the goals of this study project.
1.6 THE RESEARCH HYPOTHESIS:
The researcher believes that it is essential to develop a hypothesis in order to have a solid foundation for this study effort. The project will be guided by this hypothesis.
The researcher is examining whether Ratio Analysis, a tool used by banks to give credit to customers, has in any way aided in this process.
The investigation will be guided by the following hypothesis as a result.
1. Ratio analysis has no relevance for bank lending, according to the null hypothesis (Ho).
2. The alternative hypothesis (H1) is that ratio analysis is a method used by banks to make loans.
3. The failure to properly analyse the borrower’s financial statements prior to giving credit is the cause of the default in non-repayment of the loan.
1.7 SUMMARY OF UNION BANK OF NIGERIA PLC’S HISTORY
As Barclays Bank Company (Dominion, Colonial and Overseas), which later went by the names Barclays Bank International United and Barclays Bank Plc, the organisation that is today known as Union Bank of Nigeria Plc first arrived in Nigeria in 1917.
Until the Banking Decree of 1969, when it was domestically incorporated under the name Barclays Bank of Nigeria Ltd and established its headquarters at 40 Marina, Lagos, it had always been a subsidiary of that bank.
Its Board of Directors (BOD) further altered this name on March 12th, 1979, to Union Bank of Nigeria Ltd, and then to Union Bank of Nigeria Plc.
It became the first Nigerian bank for its counterpart to have 80% Nigerian ownership as a result of the change in the shareholding structure, which went from 80% Nigeria ownership to 20% Barclays Bank Plc.
However, Barclays Bank Plc recently gave up its 20% stake, leaving it with 11,000 employees and over 250 locations dispersed across the nation. Additionally, it has locations in London and New York.
The parent bank, Barclays Bank Plc, is the agency in all other transactions with the outside world. As time went by, Union Bank Nig. Plc, has made a name for itself as a pioneer in the banking sector.
The achievement of net profit over the previous five years speaks for itself. This has been made possible by the employees’ unselfish work, which has helped the bank grow to be so large.
In fact, it has the most workers of any sector of the banking industry. Its motto is “Big, Strong and Reliable” in all senses, including its capital and reserve basis.
1.8 DEFINITION OF TERMS
(a) LENDING: This refers to giving money to someone else with the expectation that they will pay it back.
(a) BANK LENDING: This refers to the process of providing loans from savings units paid into a bank to clients in need.
(c) RATIO: This method simplifies significant figure comparison and expresses the relationship as a percentage, making it possible to evaluate a borrower’s financial statements.
(d) FINANCIAL STATEMENT: This consists of a balance sheet, a profit and loss statement, and a statement of the sources and use of money. Reports on managerial success or failure are provided.
P.M.O.S. stands for profit margin on sales.
R.O.T.A. stands for Return On Total Assets.
R.O.E. stands for return on equity.
(h) LOAN PORTFOLIO: A borrower’s current financial needs and the reason for requiring such an account are referred to as their loan portfolio.
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