The field of economic management needs from financial executive to measure the performance by using best tools. The effectiveness of magnitude relation analysis cannot be neglected owing to its wide contributions in measure money performance. The aim of this analysis study is to investigate the effectiveness of magnitude relation analysis, as necessary tool for measure the performance of organization by applying the magnitude relation analysis on six business banks of Pakistan. The final tools of magnitude relation analysis tries to live the money performance in terms of gain, solvency, plus management (efficiency), debt management, shareholders and market. The matter has been known because the tools of magnitude relation analysis don't seem to be universal and that they vary from business to business, like industry needs completely different tools of magnitude relation analysis as compared to a producing or commerce company. By using quantitative analysis, the analysis are includes the six business banks of Pakistan, as well as Allied Banking limited, Bank Al-Habib limited, Faysal Bank limited, Habib Bank limited, Muslim Commercial limited and Meezan Bank limited. The conclusion of analysis study relies upon analysis findings, accomplishment level of responsive analysis queries, analysis aims and objectives and hypothesis testing. The analysis study concludes that though the magnitude relation analysis continues to be an efficient tool of measure the money performance; however the higher results are often achieved, once the business connected tools are used for measure the performance.
Acknowledgement
This business research project has been done for finishing requirements of MBA from Lahore School of Economics (LSE).
First of All, I would like to thank my parents who put me through all the ups and downs of life, and whom prayers and efforts helped me to achieve this milestone.
Secondly, I would like to thank my supervisor, Professor F.A Fareedy, Mam Haddiah and Mam Hudah for the kind assistance & encouragement in the work of finishing thesis
I would like to thank the relatives, colleagues & friends for their cooperation & support with useful information. This thesis is being done the way it is due to the useful information, insights & knowledge provided by supervisor, class lectures & work books.
Student Declaration
It has been declared that this thesis report is purely my own work and there is no any doubt of validity and reliability about the quality of report. The primary data has been based upon genuine and real calculations of ratio analysis and the secondary data sources are properly referenced by Harvard Referencing Style.
I also declare that, I have made this dissertation as per best of my knowledge, understanding and according to the data available and this report can be used for research purpose and for getting knowledge about ratio analysis and the tools of ratio analysis . The key focus of research was to complete the degree requirement, based upon original and empirical research.
Regards,
Muhammad Zain Nadeem
Table of Contents
1. Introduction
This research study is about the effectiveness of a performance measuring tools analysis, called ratio analysis. In the first chapter of this report, for the purpose of information the introductory literature have been addressed the report reader about the background study, nature of project, the aims and objectives, target area, scope of work and other parameters of introduction have been completed into this chapter. The introductory literature in this chapter provides the input for moving to the next chapters of report. In the end, a brief overview of chapters has been included for informing the report reader about the brief introduction about the all chapters of report.
1.1 Background
"Planning is the key to the financial manager's success… any good plan must be related to the firm's existing strengths and weaknesses and The strengths must be understood if they are to be used to proper advantage and the weaknesses must be recognised if corrective action is to be taken… the financial manager can plan his future financial requirements in accordance with the forecasting and budgeting procedures" (Weston and Brigham, 1979); (Whittaker, 1990).
The performance management is covering multiple aspects of business, and financial performance management is an important brand of performance management, in which the financial performance of company is measured with the help of different performance measurement tools, as ratio analysis is one of them (Wood and Sangster, 2005); (Anantadjaya, 2011, p55); (Vélez-González, Pradhan and Weech-Maldonado, 2011); (Atrill and McLane, 2006); (Bryan, 2007); (Whittaker, 1990). The companies are employing ratio analysis for measuring their financial performance. The definition of ratio analysis has been presented by many authors, experts and institutions such as "a tool used by individuals to conduct a quantitative analysis of information in a company's financial statement, calculated by financial statement of companies" (Loth, 2007). This research study is aimed to confirm the impact of ratio analysis tools towards improving organizational performance through analysing the relationship between different components of financial statements, published by companies for their users.
1.1.1 Financial Performance
The measurement of financial performance is very important for companies to understand their current position financially. The ultimate objective of measuring financial performance is to ensure the financial strength of company, as financial strength of an organization is considered significant performance indicator for competitiveness (Ponraj and Rajendran, 2009). The importance of There is positive relationship between financial performance and ratio analysis, because the ratio analysis is vital element of fundamental analysis, which attempts to measure the financial performance of the company. The tool of ratio analysis is used to understand the financial health of business entity, measured by calculating the current year's performance with previous years (Usman, 2011). The (Anantadjaya, 2011, p55) argues that the ratio analysis is considered as the primary tool of evaluation in the field of finance and accounting. The financial performance can b measured by different ways, but ratio analysis is highly attractive choice (Tutor2u.net, 2009). These arguments are confirming the role of ratio analysis in financial performance. This research study is aimed to confirm the role of ratio analysis in measuring the financial performance through applying the ratio analysis on the six commercial banks of Pakistan.
1.1.2 Ratio Analysis
The ratio analysis is defined by (Lane, 2002) as, "it's a kind of financial statement analysis that is used to obtain a quick indication of firm's financial performance through analyzing the relationship between several elements or areas of company through using certain ratios such as profitability ratios, market value ratios, asset management ratios, debt management ratios and share holder's ratios" (Lane, 2002); (Wood and Sangster, 2005); (Meigs et al., 1999). In addition to this, the further categories of ratio analysis include, investor ratios, gearing ratios and working capital management ratios etc (Bized, 2003). The different research, authors and experts have confirmed the ratio analysis as an important tool for measuring financial performance (Altman, 1968), (Anantadjaya, 2011, p55); (Wood and Sangster, 2005).
The tools of ratio analysis are being considered as the ratios, which are many in numbers and classified within specific groups such as profitability ratios includes sub-ratios such as current ratio, profit margin ratio, return on asset ratios, return on investment ratio, return on capital employed ratio and return on equity ratio etc. (Loth, 2012). The General tools of ratio analysis are indicated towards general ratio, which are being used for analyzing the financial performance of companies such as, liquidity ratio, asset management ratios, debt management ratio, profitability ratios and market ratios etc (Appendix 8) (Brigham and Ehrhardt, 2008); (Wood and Sangster, 2005).
Liquidity Ratios
The liquidity refers towards liquid assets that is either cash or quickly converted into cash for paying obligation. The liquidity ratios indicate that how much cash is available with the company. The higher the liquidity is, the more company is financially stable (Brigham and Ehrhardt, 2008). The liquidity ratios employ following ratios.
Current Ratio: (Current Assets / Current Liabilities)
The current Ratio is representing the solvency of company means company's ability to meet its short term liabilities. The current ratio is calculated by dividing current assets with current liabilities (Reuters, 2001); (Wood and Sangster, 2005). The favourable trend is the excess of current assets more than current liabilities.
Quick Ratio: (Current Assets - Inventory / Current Liabilities)
The quick ratio is another tool of liquidity, called acid test ratio. This ratio is calculated by excluding the inventory from current assets, and dividing the current assets with current liabilities. The inventory is less liquid asset that are why it is excluded from assets (Reuters, 2001). The favourable quick ratio must be excessive as compared to current liabilities (Wood and Sangster, 2005).
Asset Management Ratio
The assets management ratios belongs to the efficiency of company, which include the sales, inventories, accounts receivable and assets. According to the (Brigham and Ehrhardt, 2008), the asset management ratios or efficiency ratios are showing that how much efficient the company is in conducting operations (Wood and Sangster, 2005).
Inventory Turnover: (Sales / Inventories)
The inventory turn of a company represents that "how efficient a business is maintaining an appropriate level of stock" (Wood and Sangster, 2005). The higher number of stock turnover represents the good financial performance of a company.
Day Sales Outstanding (DSO): (Receivables / Annual Sales / 365)
The day sales outstanding ratio is actually the average collection period (ACP) that is used for evaluating the performance of accounts receivable. The day sales outstanding helps to assess that how much day's sales are tied up with receivables and it is calculated by dividing accounts receivable by average sales per days. The average sales per day can be calculated by dividing annual sales with 365 days. The favourable trends are, when DSO ratio is less than industry average ratio (Brigham and Ehrhardt, 2008); (Wood and Sangster, 2005).
Fixed Asset Turnover: (Sales / Net Fixed Assets)
The efficiency of a company, regarding use of its fixed assets (plant and equipment) is better calculated by fixed assets turnover ratio. The fixed assets turnover ratio is calculated by dividing sales with net fixed assets.
Total Asset Turnover: (Sales / Total Assets)
The total assets turnover ratio attempts to explain the turnover of all assets of a company. The total asset turnover is calculated by dividing total sales with total assets of company (Brigham and Ehrhardt, 2008).
Debt Management Ratio
The debt management ratios attempts to explain the relationship between total liabilities, total assets, earnings before interest and taxes etc. The debt management ratio explains the leveraging of company, how much debt is being used by company (Brigham and Ehrhardt, 2008). The results of debt management ratios include following ratios.
Total Debt to Total Assets: (Total Liabilities / Total Assets)
The total debt to total assets ratio explains the relationship between total liabilities and total assets of a company that measures the percentage of funds provided by current liabilities and long term debt. It is calculated by dividing total liabilities with total assets of a company. The preferable condition is to have low debt ratio as compared to industry average. A high ratio indicates that the company is being suppliers by creditors more than shareholders (Brigham and Ehrhardt, 2008).
Time Interest Series: (EBIT / Interest Charges)
The Time interest series is called the times interest earned (TIE) ratio that measures the extent to which operating income can decline before the firm is unable to meet its annual interest costs. This ratio provides the safety cushions for avoiding bankruptcy or insolvency. The favourable trend is to have TIE ratio near to the industry average TIE ratio of above the industry average TIE ratio. It is calculated by dividing EBIT with interest charges (Brigham and Ehrhardt, 2008).
EBIDTA Coverage: (EBIDTA + Lease Payment / Interest + All Payments)
The earnings before interest, taxes, depreciation and amortization (EBIDTA) coverage ratio better assess the company's ability to meet the fluctuations of interest on its debt. The EBITDTA coverage is calculated by formula defined above (Brigham and Ehrhardt, 2008).
Profitability Ratio
The profitability ratios actually represent the profitability of a company that is actually resulting of decisions and policies of a company (KBR, 2000). The profitability ratios are showing the overall efficiency and performance of a company (Peavler, 2009). The profitability ratios, unlike other ratios, show the combined effects of debt management, asset management and liquidity of a company towards operating results or financial performance of a company (Brigham and Ehrhardt, 2008). The profitability ratios include the following ratio for explaining profitability of a company.
Profit Margin on Sales: (Net Income / Sales)
The profitability of a company can be determined better by apply profit margin on sales ratio that is calculated by net income with total revenue or sales of company. The purpose of using profit margin on sales ratio is to extract profit per rupee of sales (Brigham and Ehrhardt, 2008). The higher return of profit margin on sales is showing the improving profitability level of a company.
Basic Earning Power: (EBIT / Total Assets)
The basis earning power ratio is showing, "the raw earning power of the firm's assets, before the influence of taxes and leverage, and it is useful for comparing firms with different tax situations and different degree of financial leverages" (Brigham and Ehrhardt, 2008). The basic earning power ratio is showing the showing the relationship between earnings before interest and taxes (EBIT) and total assets of a company (Wood and Sangster, 2005).
Return on Total Assets: (Net Income / Total Assets)
The Return on Assets (ROA) is explaining the relationship between the net income and total assets. The ROA ratio explains that how much return the company is getting by utilizing the assets (Brigham and Ehrhardt, 2008); (Investopedia, 2006). The ROA is calculated by dividing the net income by totals assets of the company (INC.com, 2012).
Return on Total Equity: (Net Income / Common Equity)
The Return on Equity (ROE) ratio is commonly used indicator of assessing the firm's ability to use its shareholder's funds. The ROE explains the relationship between net income and shareholder's equity. The favourable trend is continuously growth of ROE (Reuters, 2001); (Brigham and Ehrhardt, 2008).
Return on Capital Employed (ROCE): (Net Income / Capital Employed)
The Return on capital employed (ROCE) is similar to the ROE, but it uses the average capital for calculating the performance of the company. The average capital is calculated by dividing opening equity with closing equity and dividing by two. The result of ROCE ratio, "illustrates not, how much the profit has been earned, but explains how well the capital has been employed for running operations" (Wood and Sangster, 2005).
Market Value Ratio
The market value ratios attempt to explain the relationship between firm's stock price with other ratios like cash flow, earnings and book value per share (Brigham and Ehrhardt, 2008). These market ratios are also called as market value ratios, "which relate an observable market value, the stock price, to book values obtained from the firm's financial statements" (Lane, 2002). The major benefit of these ratio is as these ratios provide the information about the past performance and future perspective of the company (Brigham and Ehrhardt, 2008). The higher market value ratios will also indicate the expected price growth and information about strong liquidity, debt management, profitability and asset management of company (Wood and Sangster, 2005). The liquidity ratios include two major ratios, price to earnings ratio (P/E) and market to book ratio (M/B).
Price to Earnings Ratio (P/E): (Price per Share / Earning per Share)
The price to earnings ratio, also called the earning multiple ratio, that provides the information how much investors are willing to pay per rupee of report profit (Brigham & Ehrhardt, 2008); (Reuters T. , P/E Ratio, 2001). The P/E ratio is calculated by dividing the price of shares with the earnings per share (EPS) or net profit per share. The price of stocks is taken the exact that date, on which the analysis is being performed. The lower P/E ratio is resulted in lower price and market value of share, while higher P/E ratio indicates that market value is expected to grow rapidly. So, the higher the P/E ratio increases the demand for shares, because investors find it beneficial as it was indicating towards rapid growth (Wood & Sangster, 2005).
Market / Book Ratio (M/B): (Market Price per Share / Book Value per Share)
Similar to the P/E ratio, another popular ratio, related to market ratio, is "market / Book ratio (M/B)". The M/B ratio is used for comparing the market price of stock with the book price (Investopedia, 2007). The M/B ratio, "measures how much a company worth at present, in comparison with the amount of capital invested by current and past shareholders into it" (ADVFN, 2011). The (Brigham & Ehrhardt, 2008) explains that, "companies with relatively high rate of return on equity generally sell at higher multiples of book value than those with low return". The M/B ratio is calculated by dividing the market price per share with book price per share of company. First the book price is needed to calculate by dividing common equity with total number of shares outstanding.
1.2 Purpose of Study
The purpose of study better explain the motivational driver, which stimulated to conduct research study (Saunders, Lewis and Thornhill, 2007). The purpose of conducting this research study is to confirm the effectiveness of ratio analysis tool for analysing the performance of companies. Secondly, the companies are having many options in selecting the performance measuring tools, but this research study has been conducted to confirm the effectiveness of ratio analysis so that it would be proved that how much effective is the ratio analysis for measuring the organizational performance and at what extent it can help in decision making. Another purpose of study is to confirm that either the general tools of ratio analysis are enough to measure the performance of all industries or every industry or company needs separate tools of ratio analysis. In the end, the purpose of study includes also to measure and compare the information of six commercial banks in Pakistan after applying the ratio analysis tool.
1.3 Research Area
The research areas indicate towards the target areas of research along with the justification to select those areas (Lancaster, 2005). This examination concentrate on incorporates the literary works about proportion examination; its practicality for occupations, its devices for bartering communities and utility ensembles, and its part good to go determination making. Advance, in this exploration ponder, the requisition of degree examination apparatus have been performed to six business banks of Pakistan for example Allied Bank Limited, Bank Al-Habib Limited, Faysal Bank Limited, Habib Bank Limited, Muslim Commercial Bank and Meezan Bank Limited. The ratio analysis has been performed by utilizing the monetary informative content of the aforementioned banks for the year of 2010 and 2011. The dialogues have proposals have been based upon the effects of proportion investigation.
1.4 Commercial Banks
The target of ratio analysis concentrate on is to apply the degree examination on business banks of Pakistan that is why the six business banks have been chosen for checking the budgetary exhibition all manages an account with the assistance of degree dissection. These segments will location the short presentation about six business banks, which have been chosen for research. The explanation to select taking after six banks is in light of the fact that; the aforementioned all banks are furnishing business saving money utilities in Pakistan plus the different business banks. Besides, there are moreover different business banks, for instance Askari Bank, NIB Bank, National Bank of Punjab, UBL Bank and so on; in any case the aforementioned banks have issued their yearly report for the year of 2011. As the exploration examine is restrained to contrast the fiscal informative content and the point of view of 2011, so these banks were not incorporated into examination think about. The presentation of both banks is exchanged ideas about taking after.
(a) Habib Bank Limited
The Habib bank Limited (HBL) is having the greatest arrangement of limbs, furnishing the business managing account utilities at national and global level. The history of HBL begins from 1947, following the foundation of Pakistan. At national level, the HBL opened its headquarter in Karachi. In 1974, the HBL was having 40% piece of the overall industry and 55% internal remote settlements and advances to SMEs. The HBL bank was nationalized in 1974 by the legislature and in 2003, the 51% imparts have been conceded to Agha Khan Fund for Economic Development (AKFED) under privatization. At worldwide level, the first limb was opened in 1951 in Colombo, Srilanka and until 1974; the system of HBL was stretched to Singapore, USA, Belgium, Netherland and different Countries. Notwithstanding The HBL is having above 1,400 branches in 25 nations worldwide, incorporating Pakistan. The results of HBL incorporate the purchaser keeping money, business saving money and Islamic managing an account utilities. The Bank's administration is almost always run by Government of Pakistan and AKFED.
(b) Meezan Bank
Meezan Bank Limited is the first bank in Pakistan, which have offered the Islamic keeping money utilities with most substantial system of Islamic keeping money and speediest developing keeping money in Pakistan. With the point of satisfying the essential target, the Meezan Bank is furnishing the clients with benefit, openness, expert air, distinguishing requirements of clients and making the society of devoted aids in Pakistan (Meezan Bank, 2012). The capability of Meezan Bank to give creative, reasonable and aggressive esteem suggestions in items through making research and advancement with the crews of speculation bankers, business bankers and shariah researchers. The aforementioned Islamic items, based upon Islamic administers and endorsed by shariah plank, are not just gathering the prerequisite of clients in the present complex and focused fiscal globe, at the same time likewise furnish the brilliance through globe class utilities, within the borders of shariah (Meezan Bank, 2012). The Meezan Bank was fused on January 27, 1997 as accessible recorded ensemble and got licence in January 2002 for business keeping money (Meezan Bank, 2012).
(c) Faysal Bank
The Faysal Bank is a business bank, created in October 3, 1994, managing in Pakistan under community's mandate 1984. The Faysal Bank is offering the business, corporate, retail and Islamic saving money utilities in Pakistan and enlisted as popular constrained team. As per the fuming of Pakistan Credit Rating Agency Limited (PACRA) and JCR-VIS outfit, the Faysal Bank is been pronounced as lifelong rating "AA" and short term rating as "A1+" (Faysal Bank, 2012). The Faysal Bank is ranked right around top 10 banks in Pakistan with having 250 marks opposite Pakistan, Rs. 290 billion PKR possessions and drive to furnish aids past the fabulousness through gathering the client necessity.
(d) Allied Bank Limited
The allied bank limited is having the manager of first bank, built in Pakistan. The history of allied bank fits in with the Australia Bank, organized in 1942, and following the freedom of Pakistan, the name of "Australia Bank" was renamed with "Allied Bank" in 1974. The Ibrahim Group obtained the possession of Allied bank in admirable 2004, under Ibrahim Leasing Limited. The Allied Bank is offering customer saving money, business saving money and corporate keeping money utilities with grid of over 800 connected limbs, solid value, stores, holdings and engineering based items.
(e) Muslim Commercial Bank Limited
The success of Muslim Commercial Bank (MCB) was raised with its over 60 year's encounters, generally positioned features, mechanical infrastructures, and moral and expert staff and administration. The MCB was organized on July 1947, nationalized in 1974 and in opposition to privatized in 1991 to Nishat Group Company. The MCB is giving saving money utilities at national and global clients through strategic non-native partnerships and subsidiaries in different nations. The MCB is having client go of 4.5 million with aggregate possessions (605 billion) and deposits (462 billion). The managing an account utilities of MCB incorporate the retail keeping money, corporate saving money, virtual saving money, Islamic keeping money and concession saving money in Pakistan.
(f) Bank Al-Habib Limited
The Bank Al-Habib was consolidated by Dawood Habib Group in 1991. The part of Dawood Habib Group was critical in station and running of Habib Bank Limited and following Nationalization of HBL, the Dawood Habib Group was allowed by Government to set up business Bank. The Bank Al-Habib is offering utilities of retail saving money, Islamic keeping money, financing saving money, MasterCard, house financing and virtual world managing an account aids in Pakistan.
1.6 Variable of Research
The research study always attempts to explain the relationship among variables. Generally, in every research, there are two kinds of research variables, such as dependent variables (DV) and independent variables (IV) (UNCP, 2006), but the extended forms of variables include intervening (mediating) variables, extraneous variables, control variables and moderator variables (NSLCH, 2012); (Brigham Uni, n.d.). The relationship between research variable can be seen as cause and effect relationship, where cause is presumed as independent variable, while effect is presumed as dependent variable. In this research study, the following variables have been employed into research process (UNCP, 2006). The dependent variables include the performance measurement (effect) that would be measure by ratio analysis tools as independent variable (Cause).
1.6 Research Aim & Objectives
The overriding purpose of conducting research study is better explained with defining research aims, objectives and research questions. The research aims defines the ultimate objective that is to be achieved in this research study, further they research objectives are set as key goals are to be achieved and they contribute to the overall aim of the research (Saunders, Lewis and Thornhill, 2007); (Victoria University, 2000); (Lancaster, 2005). In this research study, the following research, aims and objectives have been formulated.
1.6.1 Aims
The point of this examination considers is to examine the usefulness of ratio analysis, as imperative device for measuring the exhibition of conglomeration by applying the ratio analysis on six business banks of Pakistan.
1.6.2 Objectives
The examination targets have been defined to attaining the examination points. The emulating research destinations have been formed for this exploration.
(1) To investigate the written works about ratio analysis and its instruments for measuring the exhibition of a group.
(2) To differentiate the general instruments of ratio analysis with ratio analysis devices for managing an account industry.
(3) To apply the ratio analysis devices for measuring the exhibition of six business banks of Pakistan.
(4) To dissect the consequences and finish up the consequences of research study.
1.7 Research Questions & Hypothesis
The direction could be furnished to research ponder with the assistance of figuring research concern and speculative articulation. The research question is defined as, "a statement that identifies the phenomenon to be studied, leading to achieving research objectives and overall aim". Secondly the research hypotheses are, "specific predictions about the nature and direction of the relationship between two variables" (Danya Int., 2003); (Berkeley, 2001). In this research, the following research questions have research hypotheses have been formulated.
1.7.1 Research Questions
The research questions have been planned, which endeavours to distinguish the sensation of research variables for example research analysis and association's exhibition.
Question 1: How the apparatuses of ratio analysis endeavour to measure the exhibition of organizations through investigating numerical associations.
Question 2: Do the general devices of ratio analysis are universal for each industry or they change from industry to industry, particularly in managing a banking industry.
Question 3: Do the devices of ratio analysis blatantly accommodate in settling on choices, based upon the effects of exhibition apparatuses.
1.7.2 Research Hypothesis
The hypothesis are unproven proclamation, which are later substantiated or refuted with the outcomes of research study. In this research study, the emulating research hypotheses have been defined.
H1: The exhibition of occupations could be measured by utilizing the tool of ratio analysis.
H2: The general instruments of ratio analysis are universal to each industry, for example exhibition of bank and production group could be measured with one standard ratio analysis tool.
H3: The findings of ratio analysis help the communities to not just recognize the potential situations, anyway in addition assist in decision making.
1.8 Scope of Research
The scope of research is speaking to the borders of research study. This research study concentrates on certain restrictions, as it tries to target the particular ranges and does not go past the impediments. The fundamental goal of this research study is to dissect the successfulness of ratio analysis, as significant apparatus for measuring the performance of organizations by applying the ratio analysis on six business banks of Pakistan. The scope of research study is restrained to the addressing ratio analysis and its devices for measuring the money related exhibition of the companies. The estimation of monetary informative content is based upon the monetary information, taken from the budgetary proclamations of all banks, taken from their web pages. The estimation of financial performance is just restrained the consequences of 2010 and 2011 and don't endeavour to measure previously, then after the fact outcomes. Facilitate the exploration additionally locations the nexus contrast between apparatuses of degree investigation, which shift from industry to industry according to their necessities and the exhibition of every one of the six banks have been measured through utilizing the just the aforementioned proportions, which have a place with the keeping money industry (Appendix 1). Furthermore, the scope of exploration contemplate tries to measure the exhibition of all banks and afterward contrast the exhibition in and the suggestions for every bank, based upon the behaviours of these banks. Final the research study think about closes the solidity of degree dissection, based upon the writing assessment, research findings, and talk on consequences, scrutinize issue and hypothesis testing.
1.9 Research Methodology
The research study concentrate on is constantly finished with the assistance of theories, methods and techniques, which are utilized for finishing with the achieving aims and objectives. The examination approach furnishes the items regarding all methods, techniques and examinations, which have been utilized for finishing research study. The methodology of research study is entirely based upon the nature of issues, being discussed within research (Saunders, Lewis and Thornhill, 2007), because the whole methodology is prepared according to the nature of issue. There are two types of research, such as qualitative research and quantitative research. The both types of research complete the research with different research process (Sekaran and Bougie, 2010). As the nature of research study is quantitative, that attempts to measure the relationship between research variables in terms of quantitative natures such as numerical values, percentages and numbers etc, so the quantitative research approach has been followed in this research. The sample of research has been selected as, the six commercial banks such as, Allied Bank Limited, Muslim Commercial Bank, Meezan Bank Limited, Faysal Bank Limited, Bank Al-Habib Limited and Habib Bank Limited. The sample has been selected by using random sampling and convenience sampling approaches (Trochim, 2006). The data have been collected through using the experimental strategy, in which the ratio analysis has been applied to measure the financial performance of all six banks, selected for this research (Saunders, Lewis and Thornhill, 2007). The analysis and discussions have been presented on the basis of results and critical overview on the ratio analysis tools and their impact towards measuring financial information. The detailed literature about research methodology has been addressed into chapter three of research report.
1.10 Expected Outcomes
The expected outcomes are also called as, expectations, refers to common believes are behaviour of variables, built due to level of understanding (Lancaster, 2005). The ratio analysis is widely accepted performance measuring tools, which is being used by organizations to measure their financial performance. Before, starting the research study, the following expectations were currently in hand.
(1) The financial performance of companies can be measured with numerous devices; anyway the ratio analysis moreover furnishes the critical effects in this respect.
(2) The outcomes of ratio analysis not just affirm the present budgetary position of companies but moreover furnish the assistance in choice making for business development.
(3) This research could affirm the positive effect of ratio analysis in measuring the financial performance of the organizations.
1.11 Review of Chapters
The purpose behind incorporating evaluation of sections is to give the review of afterward parts, incorporated into exploration report, for the purpose that the reader may take a review of research study before moving to the afterward sections. This research report has been partitioned into six parts, of which every section of the report is lecturing the literary works regarding the particular range of the research study. The parts regarding the every section are given accompanying;
Chapter Two: Review of Literature
In this part, the review of literature has been presented. The motivation behind giving writing analyses is to incorporate the past research studies, which have been presently exhibited by special researcher and specialists identified with writing analysis and different devices of measuring money related exhibition of companies. Encourage, the literature review assessment likewise furnishes the different ways of intuition on this research topic.
Chapter Three: Research Methodology
In this part, the research methodology of research report has been displayed, in which the plausible alternatives have been sketched out, good to go for utilizing into examination. The details about research methods, techniques and tools have been spoke to and supported, which have been utilized into research.
(c) Chapter Four: Research Findings and Analysis
In this chapter, the research findings have been presented along with the critical analysis and discussion on the result, for the purpose of converting the findings into useful information that can help in answering research questions, achieving research objectives, testing hypothesis and concluding research studies (Lancaster, 2005). The findings have been gotten by applying the ratio analysis on the budgetary articulations of each of the six banks for the year of 2011 and 2010. The presentation of findings has been introduced with the assistance of tables and bar graphs. The analysis has been made with basic analysis of findings and finishes the drifts, being reflected by the findings of research.
Chapter Five and Six : Conclusion and Recommendations
In this section the research has been finished up and proposals have been made. When closing the exploration, the affirmation of examination culmination have been checked through performing certain tests, for example finishing level of points, targets and research issues on top of the speculation testing for confirming or negating hypothetical statements . The summation has been drawn on the foundation of research findings, data analysis and results of experiments. The recommendations have been exhibited toward the finale of the chapter by focusing towards indicating areas of research, which need further investigation and moreover speaking to the guidelines for financial analysis and directors to accompany the guidelines before set up to utilize ratio analysis for measuring the financial performance.
1.12 Chapter Summary
This is first section of research that furnishes the initial written works concerning the research study. The major zones of this research study are, background of study, introduction to ratio analysis and the tools of ratio analysis, introduction to banks, important of study, scope of study, variable of research, the aims, objectives and research questions, research methodology, expected outcomes and the review of chapter. The motivation behind this chapter is to address the readers with complete starting information concerning the research study and its contrasting viewpoints. This chapter furnishes the data to the afterward chapters of research study.
2. Literature Review
This research study is aimed to explore the effectiveness of ratio analysis towards measuring the financial performance of companies by using the example of six commercial banks of Pakistan. The literature review is attempting to evaluate the previous research studies, presented by scholars and experts, about the effectiveness and viability of ratio analysis. The secondary reason of conducted literature review is to generate and refine your research ideas, which have already explored by other researchers (Saunders, Lewis and Thornhill, 2007).
2.1 Literature Review
The measuring of performance in organization is an essential part of business planning. Every business plan, communication plan, marketing plan and even financial planning also contains the performance monitoring part, in which the performance measurement tools are defined, which help in measuring the performance of strategic planning or any other planning (Ponraj and Rajendran, 2009); (DiBemardino, 2011); (Kotler and Keller, 2009); (Chao, Yu and Chen, 2010). The ultimate objective of measuring financial performance is to ensure the financial strength of company, as financial strength of an organization is considered significant performance indicator for competitiveness (Ponraj and Rajendran, 2009).
The importance of performance measuring is being considered importantly as organizations are widely using the performance measuring systems to measure the performance of their organization, because they believe that it plays an important role in the development of firm's strategy and also evaluating the level of accomplishment of organizational strategic objectives (Vélez-González, Pradhan and Weech-Maldonado, 2011); (DiBemardino, 2011).
The research (Vélez-González, Pradhan and Weech-Maldonado, 2011) have presented into its research study that companies should also use the non-financial performance measuring tools instead of using financial measuring tool. There are also other tools of measuring performance, which are not financial, but their impact is also signification towards improving the financial performance as well. The non-financial performance measuring tools are efficiency, productivity and quality, positively improving the performance of other aspects well. These arguments have been included into this literature review to highlight the importance of performance measuring, not only with the help of financial performance measuring tools, but also the non-financial performance measuring tools, similar to approach of non-financial tools such as corporate philanthropy, talent management and key success factors (Mothilal et al., 2012); (WANG and QIAN, 2011); (Li, Zhang and Zhao, 2011); (DiBemardino, 2011).
The research by (Chao, Yu and Chen, 2010) explores the information about the one performance measuring tool for holding companies, called "Data Envelopment Analysis (DEA). The older version of this model was lacking in giving optimal performance, because now a day holding companies are facing many issues due to simultaneous multiple product functions. The latest version of this model is called, Multi-Activity DEA that attempts to measure the efficiency along with indicating towards sources of inefficiency. According to (Moneva and Ortas, 2010), the effective management of environmental factors also plays vital role in improving performance. For this purpose, the tool is used as, least square model (PLS) that attempts to measure the company's performance through analyzing the relationship between environmental factors and financial performance of company. The modern approach of performance measurement is focusing towards intangible capital, such as profit per employee that is more accurate, complete and adequate, rather than traditional performance measuring tools such as cash flows, balance sheet or return on investment capital (ROIC) (Bryan, 2007).
The (Anantadjaya, 2011, p55) argues that the ratio analysis is considered as the primary tool of evaluation in the field of finance and accounting. The research study presents the comparison between ratio analysis and the employee's performance. The traditional approaches about evaluating the performance of organizations were based upon the evaluating the performance of employees, if the employees were giving productivity, that means, organization is giving productivity, but now a day, due to increasing complexity of operations, the modern approaches are using the ratio analysis tools and other tools for measuring the performance of company.
Besides the effectiveness of ratio analysis, it also has some draw backs, which restricts the managers to use the ratio analysis for measuring different kinds of performance about organization. First major limitation of ratio analysis is, it does not provide the information about the past performance (Tutor2u.net, 2009), because it provides the financial performance of year, for whom it has been calculated, but not the previous year's performance. Secondly, the ratio analysis can address only quantitative issues, but it cannot identify the qualitative factors such as customer service, product quality etc. Another allegation is put towards ratio analysis is, it tells just number, which are needed to be analyzed and interpreted, but does not express the cautions for analyzing performance (Peavler, 2007). The approach of ratio analysis is also limited due to availability of different accounting methods, because if a company is using different methods for inventory valuation, then accuracy of ratio analysis is widely affected. The ratio analysis uses the information of financial statements, and most of organization does window dressing (manipulation of facts) of their financial statements and results might be presented as false. It doesn't provide time value of money and also ignores the cost of capital investment that is needed for generating earnings (Anon, 2007); (Kayush, 2010).
One research by (Bryan, 2007) is presenting contradiction against the effectiveness of ratio analysis tools for measuring financial performance of company. The researcher claims that the traditional methods such as cash flow, balance sheet, return on invested capital and other tools of ratio analysis are not providing the accurate and adequate information about the financial performance of a company. The researcher recommends focusing towards measuring the performance of intangible capital such as profit per employee, rather than using physical capital based performance evaluation.
The general tools of ratio analysis incorporate the examination of stock or production identified viewpoints for example "activity ratios" or "efficiency ratios" and the majority of these ratios would not be able to be connected towards managing a banking industry. The managing a banking related ratios incorporate some of general ratios and some more particular ratios, identified with keeping money industry, which assist in measuring the budgetary exhibition of banks.
2.1.1 Articles and Analysis
2.1.1.1 Article 1:
Assessing Bank and Bank Branch Performance Modelling Considerations and Approaches
The banking industry has been the object of DEA analyses by a significant number of researchers and probably is the most heavily studied of all business sectors. Various DEA models have been applied in performance assessing problems, and the banks' complex production processes have further motivated the development and improvement of DEA techniques. The main application areas for DEA in bank and branch performance analysis include the following: efficiency ranking; resource allocation, efficiency trends investigation; environmental impacts compensation; examining the impacts of new technology, ownership, deregulation, corporate, economic, and political events, etc. (Joseph C.Paradi)
2.1.1.2 Article 2:
The Application of Data Envelopment Analysis in Conjunction with Financial Ratios for Bank Performance Evaluation
While financial ratios are currently the method most often used to evaluate a bank's performance, there is no clear-cut rationale which would allow one to acquire a composite score on the overall financial soundness of a bank. This paper demonstrates the application of DEA (Data Envelopment Analysis) in conjunction with financial ratios to help bank regulators in Taiwan not only to distinguish the efficient banks from the inefficient ones but also to gain insight into various financial dimensions that somehow link to the bank's financial operational decisions. (Yeh, 1996)
2.1.1.3 Article 3:
Ratio Analysis is a Powerful Financial Analysis Tool for Your Firm
Money related proportion examination is one apparatus of examining and analyzing connections between distinctive bits of money related informative data. You utilize informative data from the livelihood comment and accounting report to ascertain fiscal proportions with a specific end goal to verify informative data concerning your minor business firm. There are any number of proportions you might compute. To take care of that situation, there are some standard degrees that most business firms utilize.
The issue with degrees is that they are useless unless they are contrasted with something. Case in point, assuming that you figure your association's liability proportion for one time period (we should declare a year) and its 50%. What finishes that totally mean? All you can take from that is that, forasmuch as the obligation degree is Total Liabilities/Total Assets, 50% of your association's possessions are financed by indebtedness. You don't know if that is exceptional or disagreeable unless you have something to contrast that 50% with. (Peavler, Business Finanace)
2.1.1.4 Article 4:
Competitive Profiling with Financial Ratio Analysis
I think effortless financial ratios are the most under-used origin of aggressive insights. No different information can hope to measure up with the straightforward fiscal proclamation for sheer substance. (Mark B. Jhonson, 2002)
Financial Ratios
The financial ratios preferable clarifies the financial performance of the group by utilizing the financial ratios, which preferred describe the financial condition of a company. The performance of a bank is preferred surveyed by utilizing the following financial ratios.
Return on Assets = (Net Income / Common Equity)
The Return on Assets (ROA) is explaining the relationship between the net income and total assets. The ROA ratio explains that how much return the company is getting by utilizing the assets (Brigham and Ehrhardt, 2008); (Investopedia, 2006). The ROA is calculated by dividing the net income by totals assets of the company (INC.com, 2012).
Return on Total Equity = (Net Income / Common Equity)
The Return on Equity (ROE) ratio is commonly used indicator of assessing the firm's ability to use its shareholder's funds. The ROE explains the relationship between net income and shareholder's equity. The favourable trend is continuously growth of ROE (Reuters, 2001); (Brigham and Ehrhardt, 2008).
Profit Before Tax Ratio (PBT)= (EBIT / Total Revenue)
The profit before tax (PBT) is also denoted with earnings before interest and taxes (EBIT). The PBT ratio is representing the company's profitability before paying the interests and taxes (Investopedia, Definition of 'Profit Before Tax - PBT', 2000). The PBT ratio is calculated by dividing the EBIT with total revenue. The increasing percentage of PBT ratio is better indication of profitability.
Gross Spread Ratio = (Net Mark-up Income / Gross Mark-up Income)
The gross spread ratio (GSR) is calculated by dividing the net mark-up income with gross mark-up income. It is basically indicates towards, "spread of interests between borrowing and lending" (Bass, 2006). Another school of thoughts explains the gross spread as, "difference between the underwriting price received by the issuing company and the actual price offered to the public" (Investopedia, 2007). But for measuring the performance of a bank, the Gross Spread Ratio is exploring the relationship between net mark-up income and gross mark-up income of a bank.
Return on Capital Employed (ROCE): (Net Income / Capital Employed)
The Return on capital employed (ROCE) is similar to the ROE, but it uses the average capital for calculating the performance of the company. The average capital is calculated by dividing opening equity with closing equity and dividing by two. The result of ROCE ratio, "illustrates not, how much the profit has been earned, but explains how well the capital has been employed for running operations" (Wood and Sangster, 2005).
Advances to Deposit Ratio = (Advances / Deposits)
The advance to deposits ratio (ADR) is describing the performance of a bank through explaining the relationship between total advances with total deposits of company (DAN, 2009). It is also called the loan to deposit ratio (Investopedia, 2007). The important aspect of this ratio is that it does not require from bank to have either too high ratio or too low ratio, but it explains the best condition, which it is balanced from both sides. For example, if a company is having too high ADR, that means the company is having poor liquidity and the problem can be arise in case of uncertain need of liquid cash. On the other hand, the low ADR is indicating that the company is not earning much from advancing operations. The ADR is calculated by dividing total advances with total deposits of bank.
Income to Expense Ratio = (Income / Expenses)
The income to expense ratio is showing the efficiency of bank's operations. The Income to expense ratio is explaining the relationship between total income and total expenses of company. The favour trend is, when income is more than expenses. The income to expense ratio is better calculated by dividing total income to total expenses of company (budgetmath.com, 2000).
Growth in Gross Income = (Gross Income / Total Revenue)
The financial performance of a bank is also calculated by growth in gross income ratio. The growth in gross income ratio attempts to determine the growth of decline in the gross income of company's current year operations. The growth in gross income can be well determined by preparing vertical analysis of income statement of bank (Investopedia, Definition of 'Vertical Analysis', 2007). The growth in gross income is calculated by dividing gross income by total revenue of bank.
Growth in Net Income = (Net Income / Total Revenue)
Similar to gross income, the measurement of net income is also another tool for measuring financial performance of company. The growth in net income is calculated by dividing the net income by total revenue of company. The growth in net income can be well determined by preparing vertical analysis of income statement of a company or bank (Investopedia, Definition of 'Vertical Analysis', 2007).
Equity to Assets Ratio = (Equity / Assets)
The common indicator of measuring financial performance is through equity to assets ratio. It is also called the shareholder's equity ratio (Atrill & McLane, 2006); (Wood & Sangster, 2005). The equity to assets ratio is explaining the risk condition of company, because is the equity is very low, that means the company portion of debt is higher in company's assets, while the higher equity is showing the less leveraging position of bank (Tesia Solutions, 2011); (Brigham & Ehrhardt, 2008).
Intermediation Cost Ratio = (Operating expense / Assets)
The intermediation cost of a bank is considered as the operating expense of a bank. The intermediation cost to assets ratio is calculated by dividing the total operating expense with total assets. The favourable trend is when intermediation cost is lower than total assets, otherwise, it will show the loss condition (Elin, 2011).
NPL Ratio = (Non-Performing Loans / Advances)
The performance of company's efficiency can also be measured by non-performing loans. The non-performing loans are those advances, which didn't performed well, either they went in bad debts or delayed, close to default (Rinaldi, 2006). The non-performing loans are calculated by dividing the total non-performing loans with total advances (Investopedia, 2007).
Earning Asset to Total Asset Ratio = (Earning Assets / Total Assets)
The earning assets of a bank are those assets, which are receiving any kind of interest, fee or return on capital, such as interest on advances etc (Harvey, 2012). The earning assets to total assets ratio is explaining the relationship between the earning assets of a bank and total assets of a bank (Investopedia, 2007); (Answers, 2008). The earning assets are calculated to by excluding the cash and fixed assets from the total assets (Shad0o0., 2011). The higher ratio of earning assets to total assets ratio is showing the company's better efficiency and performance.
