THE ROLES OF FINANCIAL RATIOS IN PREDICTING BANKS GOING CONCERN IN NIGERIA.

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ABSTRACT

The study examine the roles played by financial ratios in the prediction of going concern of deposit money banks in Nigeria.it was based on the following objectives  (1) To measure the effectiveness of financial ratios in financial statements analysis of deposit money banks in Nigeria. (2) To determine how financial ratios can be used to predict the continuity of deposit money banks in Nigeria. (3) To identify the challenges/problems faced by deposit money banks in Nigeria in using financial ratios in financial statement analysis. The data was sourced through secondary data generated from the annual reports and accounts of deposit money banks in Nigeria for the period of five years (2017-2021).the result of the study shows that financial ratios are effective in the analysis and prediction of going concern of banks. Based on the findings the study recommends that it is evident that some of the banks have some problems regarding some single ratios, but on a combined effect assessment, all the banks have performed fairly well. The return on investments and net worth respectively were very low. It is therefore recommended that the management of the banks under study should carefully analyze all their assets both fixed and current and their subsidiaries with a view to selling off those considered as not contributing enough to their asset mix targets. It is recommended that the companies should seek means of reducing their total debt level as this will reduce their provision for liabilities and charges as well as clear tax liabilities that are outstanding which dominate their entries for amount due to creditors over a year.

 

 






TABLE OF CONTENTS

Dedication………………………………………………………………i

Declaration……………………………………………………………..ii

Certification/Approval………………………….......………….………iii

Acknowledgement………………-----…………………………………iv

Table of contents………………………………………………………vi

List of tables………………………--…………………………………vii

Abstract………………………………………………………………viii


CHAPTER ONE

1.1 Background of the Study……………………………………………….1

1.2 Statement of the Problem………………………………………………3

1.3 Objectives of the Study…………………...………………………………4

1.4 Research Questions……………………...………………………………...4

1.5 Research Hypothesis…………………...………………………………….5

1.6 Significance of the Study…………………...……………………………5

1.7 Scope of the Study…………………………………..……………………5

1.8 Definition of key Terms............................................................................6


CHAPTER TWO

LITERATURE REVIEW

2.1   Introduction...........................................................................................................7

2.2 The concept of financial ratios………………………………………7

2.2.1 Classification of financial ratios……………...……………………9

2.2.2 Standard of comparison…………….……………………………16

2.2.3 Types of comparison……………………………………………16

2.2.4 Objectives of financial ratios……………………………………17

2.2.5 Benefits and usefulness of financial ratios…………………….18

2.2.6 Problems of financial ratios……………………………………18

2.2.7 Limitations of financial ratios…………………………………19

2.2.8 Going Concern as an Accounting Concept...............................22

2.3. Review of Empirical Literatures.................................................. 23

2.4  Theoretical Framework..................................................................25

2.4.1 Financial Intermediation Theory of banking................................25

2.4.2 Credit Creation Theory of Banking..............................................25

2.4.3 Older fractional Reserve theory....................................................26


CHAPTERTHREE

RESEARCH METHODOLOGY

3.1 Introduction…………………………………………………………27

3.2 Research Design……………………………………….………………….27

3.3 Population of the study…………………………………………………..27

3.4 Sample size and sampling technique…………………………………….28

3.5 Sources of data collection………………………………………………..29

3.6 Method of data collection……………………….………………………..29

3.7 Variables and their measurement…………………………………………30


CHAPTER FOUR

DATE PRESENTATION AND ANALYSIS

4.1 Introduction………………………………………………………………32

4.2 Presentation and analysis of data………………………………………….32

4.3 Analysis of other Data…………………………………………………….33

4.4 Test of Hypothesis.........................................................................35

4.5 Summary of the Findings………………………………………...36


CHAPTER FIVE

SUMMARY CONCLUSION AND RECOMMENDATION

5.1 Summary………………………………………………………….37

5.2 Conclusion………………………………………………………..38

5.3 Recommendation………………………………….……………....39

5.4 Frontiers for Further research..........................................................39

REFERENCES

APPENDIX

                

                                   


 

LIST OF TABLES

Table 3.1 population of the study…………………………………………..27

Table 3.2 sampled banks of the study…………………………………….28

Table 4.1 computation of current ratios…………………………………33

Table 4.2 computation of net working capital ratios…………….33

Tables 4.3 computation of debt to equity ratios……………………34

Table 4.4 computation of return on equity………………………………34

Table 4.5 computation of return on capital employed……………35

 

 

 





CHAPTER ONE

INTRODUCTION


1.1 BACKGROUND TO THE STUDY

Ratio analysis is a very important tool of financial analysis. Financial analysis is the process of evaluating accounting data in order to determine the operational performance as well as the financial position of the firm. Financial analysis provides information as to the financial strength and weakness of a firm and this helps in building up the framework for future plans of the firm. Hence financial analysis is the first in making plans as it clears ground for sophisticated forecasting and actual planning activities since a good understanding of the past is a pre-requisite for future predictions.

According to Pandey (2000), financial analysis is the process of identifying the financial  strengths  and  weaknesses  of  the  firm  by  properly  establishing relationships  between  the  items  of  balance  sheet  and  the  profit  and  loss  account. Financial  analysis  can  be  undertaken  by  management  of  the  firm,  or  by  parties outside  the  firm,  viz,  owners,  creditors,  investors  and  others. 

Financial information provided in financial statements are useful in business decisions. However, it must be noted that financial statements are means to an end and not an end in themselves. In view of the summarized nature of the information contained in financial statements, they need to be analyzed and interpreted by means of financial ratios to enable management and stakeholders understand them and make well-informed predictions.

Ratio analysis is perhaps the most widely used. A ratio is simply the relationship between the one number and another number. The  level  of historical  trends  of  these  ratios  can  be  used  to  make  inferences about a  company’s financial  condition,  its  operations  and  attractiveness  as  an  investment. A  business  is  considered  a  going concern  if  it  is  capable  of  earning  a  reasonable  net  income  and  there  is  no intention  or  threat  from  any  source. 

Closely related is the distinction between the value of a bank in liquidation and the value of a bank as a going concern. For instance, one of the motivations for the 1991 legislation was that the net value of a bank tends to decrease when the bank ceases to be a going concern and moves into liquidation model. Thus, the level of capital that is adequate for regulatory and supervisory purposes may differ between banks operating normally and banks in the process of liquidation.

Udeh (2006) defined financial ratio as quotient of two mathematical expressions and or as the relationship between two or more items expressed in figures. A ratio is used in financial analysis as a yardstick for evaluating the financial positions and performance of a firm as the absolute figures contained in the financial statements do not provide meaningful information on the performance and financial position of a firm.

According to Igben (1999:423), “Accounting {or financial} ratio is a proportion or fraction or percentage expressing the relationship between one item in a set financial statements and another item in the financial statements. Accounting ratios are the most powerful of all tools used in analyzed and interpreting financial statements”.

Ratios are indices derive from expressing the relationship between financial data. A ratio is an expression of mathematical relationship between one quality and another usually expressed as a fraction, a percentage, and decimal. E.g. the ratio 2:1 may be ½, 200 %.( Iwora G.A.2005)

Going concern is one of the accounting concepts; it means that the business unit will operate in perpetuity, i.e. the business is not expected to be liquidated in the foreseeable future. A business is considered a going concern if it is capable of earning a reasonable net income and there is no intention or threat from any source. The directors are mandated by the companies and allied matter Act 1990 CAMA to prepare periodic financial statements that give a summary of the business transaction for the financial period under question. 

Going concern as an accounting concept states that an enterprise will continue in operational existence for the foreseeable future. This means in particular that the profit and loss account and balance sheet assume no intention or necessity to liquidate or curtail significantly the scale of operation. (Adeniyi a. Adeniji 2012)

The 'going concern' concept assumes that the business will remain in existence long enough for all the assets of the business to be fully utilized. Utilized assets means obtaining the complete benefit from their earning potential. Ratios generally are not useful unless they are benchmarked against something else, like past performance or another company. Thus, the ratios of firms in different industries, which face different risks, capital requirements, and competition are usually hard to compare.

Ogunleye (2002) classified the cause of banks going concern into institutional economic and political factors as well as regulatory and supervisory inadequacies. While Ebhodaghe (1995) attributed bank failure to economic downturn, inhibitive policy environment and management problems.

There are several ways of classifying ratios and could be based on source of data, what the ratios are meant to measure and users for whom they are primarily computed. A study in 1930s and several ones later conclude that failing firms exhibit significantly different ratio measurements than continuing entities. Therefore, observed evidence for five years prior to failure was cited as conclusive evidence that ratio analysis can be useful in the prediction of failure. For many years Nigerian banking system has been experiencing spate of financial distress which from time to time lead to failure of number of banks with attendant capital loss, employment loss and socially undesirable consequences. It is therefore desirable to find a way of detecting deteriorate financial conditions of Nigerian banks.  Predicting the financial failure of deposit money banks is one of the main topics that many international institutions have dealt with, due to its negative impact on companies, investors and the economy as a whole. The importance of financial forecasting also lies in helping decisions makers to take the appropriate decisions as far as financing is concerned.  In addition to this, this latter helps reduce the degree of uncertainty as it provides an evaluation of the potential risk that may happen in the future. 

It is on this argument that this work lies to assess the roles of financial ratios in predicting banks going concern in Nigeria. 

1.2 Statement of the Research Problem

With  the  current  political  and  economic  difficulties  in  Nigeria, banks are  invariably  subjected  to  pressure  and  stress  which  in  effect  has constituted  a  threat  to  the  corporate  existence  of  these  businesses  which  if  not properly  managed  could  lead  to total  failure.  As  such, banking sectors  became  a  battlefield  for  survival  of  the  fittest  with banks being forced  to  assume  greater  risks and this makes the banks particularly prone to failure. Financial  ratio  analysis  is  used  to  compute,  analyze,  predict the  continuity of banks.  It is against this background that the researcher intends to fill this gap. The main aim is to highlight the roles of financial ratios in predicting banks going concern.   

The  problem  of  the study  Highlights the  need  of  many  parties such as investors, lenders  and  auditors,  and  others,  to see the bank's  ability  to survive  and  continuity  away  from failing  due  to  the  negative  impact  of  distress  banks on  the national economy  and the consequent of  many  problems given  the  multiplicity  of  uses of financial ratios, it  is  useful  to  know any  of these ratios  which, if  used together can give  an  accurate prediction  from  the  failures of banks before it occurs  in a period  of  time  to  help the banks to  take  appropriate  action  and  possible solutions  before it  is  too late.

In view of the above stated problems, this research is embarked upon to identify the roles of financial ratio in predicting banks going concern of Nigeria Deposit money banks.

1.3 Objective of the Study

The main aims and objective of this study is  to examine the roles played by financial  ratio analysis  in  predicting going concern in the Nigerian  banking sector. And the specific objectives are to;

        i.            measure the effectiveness of financial ratios in financial statements analysis of deposit money banks in Nigeria.

      ii.            determine how financial ratios can be used to predict the continuity of deposit money banks in Nigeria.

    iii.            identify the challenges/problems faced by deposit money banks in Nigeria in using financial ratios in financial statement analysis.

1.4 Research Questions

This study attempts to find answers to the following questions

  1. How effective is financial ratios in financial statements analysis of deposit money banks in   Nigeria?
  2. Can continuity of deposit money banks be predicted using financial ratios?
  3. Is there challenges/problems faced by deposit money banks in Nigeria using financial ratios in     financial statement analysis?

1.5 Research Hypotheses

A hypothesis is a tentative and probable explanation of relationship between two or more variables that create a state of affairs or phenomenon. In view of this, the following hypotheses were formulated to guide the study.

H1: financial ratios are not effective in financial statements analysis of deposit money banks.

H2: financial ratios cannot be use to predict the continuity of deposit money banks in Nigeria.

H3: There are no challenges/problems faced by deposit money banks in Nigeria in using financial ratios in financial statement analysis

1.6 Scope of the Study

The scope of this study was centered on the role of financial ratios in predicting banks going concern. The analysis covers the trend analysis and industry average, it will consider the analysis of outsiders with the use of published financial statements i.e. statement of financial position and statement of comprehensive income of some selected banks and it covers a period of five years (I.e from 2016 -2020).


1.7 Significance of the Study

The researcher believes that this research will be very significance to some parties which include;

The management of deposit money banks in Nigeria may stands to benefit from the findings of the research that the study would prompt them on roles of financial ratios in predicting banks going concern.

It also hoped that the study may be important to government and its agencies particularly those established to regulate to oversee the activities of deposit money banks in Nigeria as it would help them to know the role of financial ratios in prediction of strength and continuity of banks.

The research would also be of importance to future researchers as it would be a guide for further research in extending the frontiers of knowledge. It would add to the knowledge reservoir in the library. It would form reference material to other students in the field of study.


1.8 Definitions of Key Terms

Bank: A bank is a financial institution that is licensed to accept deposit from the public and creates a demand deposit while simultaneously making loans

Deposit: A sum of money paid into a bank.

Financial Ratios:  Financial ratios are created with the use of numerical values taken from Financial statements to gain meaningful information about a company. The numbers found in the company's financial statement, income statement, balance sheet, cashflow statement are use to perform quantitative analysis and interpretation thereby assessing a company's liquidity, leverage, growth, margins, profitability, valuation and so on.

Going Concern: The assumption is that the business unit will operate in perpetuity; that is the business is not expected to be liquidated in the foreceable future. A business is considered a going concern if it is capable of earning reasonable net income and there is no intention or threat from any source to curtail significantly in line of business in the foreceable future.



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