BUSINESS FACULTY

FINANCIAL STATEMENT ANALYSIS: THE

CASE OF ABYSSINIA BANK

PREPARED BY:
RITA W/GEBRIEL
MARTHA TESFAYE

APRIL 2012
SMUC
ADDIS ABABA
FINANCIAL STATEMENT ANALYSIS IN THE
CASE OF ABYSSINIA BANK

A SENIOR ESSAY SUBMITTED TO THE

DEPARTMENT OF ACCOUNTING
BUSINESS FACULTY
ST. MARY’S UNIVERSITY COLLEGE

IN PARTIAL FULFILLMENT OF THE REQUIREMENTS

FOR THE DEGREE OF BACHELOR OF ARTS IN
ACCOUNTING

BY:
RITA W/GEBRIEL
MARTHA TESFAYE

APRIL 2012
SMUC
ADDIS ABABA
 ST. MARY'S UNIVERSITY COLLEGE

FINANCIAL STATEMENT ANALYSIS IN THE

CASE OF ABYSSINIA BANK

BY:
RITA W/GEBRIEL
MARTHA TESFAYE

FACULTY OF BUSINESS
DEPARTMENT OF ACCOUNTING

APPROVED BY THE COMMITTEE OF EXAMINERS

Department Head Signature

Advisor Signature

Internal Examiner Signature

External Examiner Signature

 ACKNOWLEDGMENTS

The generous cooperation of many people has contributed for the success
and completion of this paper, our special gratitude goes to our advisor
Dergu Damasie for his commitment on the paper at each stage.

We are very grateful especially to all of our friends for their

encouragement and moral support.

We also like to extend thanks to the Bank of Abyssinia specially, the

department of finance for availing the necessary information for the
study.

Most of all, we thank the lord Jesus Christ for his unfailing love.

Thank you All!!!

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 TABLE OF CONTENTS
Contents Pages
Acknowledgments .......................................................................... i
Table of Content ............................................................................. ii
List of Tables ................................................................................. iv
List of Figure ................................................................................. v
Acronyms ....................................................................................... vi
CHAPTER ONE: INTRODUCTION
1.1. Background of the Study ................................................... 1
1.2. Background of the Organization ......................................... 2
1.3. Statement of the Problem.................................................... 3
1.4. Research Questions ........................................................... 4
1.5. Objectives of the Study ..................................................... 4
1.5.1. General Objective ...................................................... 4
1.5.2. Specific Objectives ..................................................... 4
1.6. Significance of the Study .................................................... 5
1.7. Scope of the Study .............................................................. 5
1.8. Research Design and Methodology ...................................... 5
1.8.1. Type of research ....................................................... 5
1.8.2. Types of Data Used ................................................... 5
1.8.3. Method of Data Collection ........................................ 5
1.8.4. Method of Data Analysis ............................................ 6
1.9. Limitation of the Study ....................................................... 6
1.10. Organization of the Study ................................................... 6
CHAPTER TWO: LITERATURE REVIEW
2.1. Financial Statement ........................................................... 7
2.2. Definition of Financial Statement Analysis ......................... 11
2.3. Types of Financial Statement Analysis ................................ 12
2.4. Purpose and Objectives of Analyzing Financial Statements . 13
2.5. Problems in financial Statement Analysis............................ 15
2.6. Financial Ratio Analysis ..................................................... 18
2.6.1. Nature of Financial Ratio Analysis ............................. 18

2
 2.6.2. Types of Financial Ratio Analysis .............................. 18
2.6.2.1. Liquidity Ratios ........................................... 19
2.6.2.2. Activity Ratio ............................................... 21
2.6.2.3. Financial Leverage Ratios ............................ 22
2.6.2.4. Profitability Ratios ....................................... 23
2.6.2.5. Market Value Ratios .................................... 24
2.6.3. Standards of Comparison .......................................... 26
2.6.3.1. Trend Analysis ............................................ 26
2.6.3.2. Industry Analysis ........................................ 26
2.6.3.3. Common Size Analysis ................................ 27
2.6.4. Use of Financial Ratios Analysis ................................ 27
2.6.5. Limitations of Financial Ratio Analysis ...................... 28
CHAPTER THREE: DATA PRESENTATION AND ANALYSIS
3.1. Financial Statement Analysis of BOA .................................. 29
3.1.1. Liquidity Ratio ........................................................... 29
3.1.2. Activity Ratio ............................................................. 31
3.1.2.1. Fixed Asset Turnover Ratio (FATOR) ................... 32
3.1.2.2. Total Asset Turnover Ratio (TATOR) .................... 32
3.1.3. Profitability Ratio ...................................................... 33
3.1.3.1. Net Profit Margin (NPM) ...................................... 34
3.1.3.2. Basic Earning Power Ratio (BEPR) ...................... 34
3.1.3.3. Return on Total Assets (ROA) ............................ 35
3.1.3.4. Return on Equity (ROE) ...................................... 36
3.1.4. Coverage Ratio .......................................................... 37
3.1.4.1. Debt to Asset Ratio (DTAR) ................................. 37
3.1.4.2. Debt to Equity Ratio (DTER) ............................... 38
3.2. Common Size Analysis ........................................................ 39
3.3. Common Base year Financial Statement ............................ 42
CHAPTER FOUR
SUMMARY OF FINDING, CONCLUSIONS AND RECOMMENDATIONS
4.1. Summary of Finding ........................................................... 47
4.2. Conclusions........................................................................ 48
4.3. Recommendations .............................................................. 49
BIBLIOGRAPHY

3
 LIST OF TABLES
Titles Pages
Table 1: Analysis of Current Ratio ...............................................................30
Table 2: Analysis of Cash Ratio ...................................................................31
Table 3: Fixed Asset turn over Ratio ............................................................32
Table 4: Total Asset turn over Ratio .............................................................33
Table 5: Net Profit Margin ..........................................................................34
Table 6: Basic Earning Power Ratio .............................................................34
Table 7: Return on Total Asset ...................................................................35
Table 8: Return on Equity Asset .................................................................36
Table 9: Coverage Ratio ..............................................................................37
Table 10: Debt to Asset Ratio .....................................................................37
Table 11: Debt to Equity Ratio ....................................................................38
Table 12: Common Size Balance Sheet .......................................................40
Table 13: Common Size Income Statement .................................................41
Table 14: Common Base Year Balance Sheet ..............................................43
Table 15: Common Base Year Income Statement: Trend ..............................44

4
 List of Figures

Figure 3.1. Liquidity Ratio ................................................................... 31

Figure 3.2. Activity Ratio ..................................................................... 33

Figure 3.3. Profitability Ratio ............................................................... 36

Figure 3.4. Coverage Ratio ................................................................... 39

Figure 3.5. Trend in Income ............................................................... 45

Figure 3.6. Trend in Expense .............................................................. 46

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 ACRONYMS
FSA: Financial Statement Analysis
BOA: Bank of Abyssinia
NBE: National Bank of Ethiopia
DSO: The Days Sales out Standing
FATOR: Fixed Asset Turn over Ratio
TOTOR: Total Asset Turn over Ratio
NPM: Net Profit Margin
BEPR: Basis Earning Power Ratio
ROA: Return on Total Assets
ROE: Return on Equity
EBIT: Earning before Interest and Taxes
DTAR: Debt to Asset Ratio
DTER: Debt to Equity Ratio
CE: Cash Equivalent
MKT: Marketable

6
 CHAPTER ONE
INTRODUCTION

1.1. Background of the Study

Financial analysis means the selection, evaluation and interpretation of
financial data along with other pertinent information to assist in
investment and decision making. Decision making is one of the most
important tasks of every company management, to make this decision
every manager need some sort of information, for instance a bank may
need financial information about the financial position, performance of
the company, the liquidity position and the like to grant a loan (Kieso,
Financial Accounting 1992:500)

Financial analysis use for internal and external purpose. For internal
purpose such as employee performance, for example, managers are
frequently evaluated and compensated on the basis of accounting
measures of performance such as profit margin and return on equity. For
external purpose financial statement are useful to parties out side the
firm including short term and long term creditors and potential investors
and evaluate the credit worthiness of borrowers (Kieso, Financial
Accounting 1992:501)

Financial statement analysis is a general term used to describe the

activity of interpreting and using, as opposed to preparing, financial
statements, and primarily accounting data (Kieso, Financial Accounting
1992:501)

In a particular service giving organizations should provide their service

efficiently and effectively so as to bring their customer satisfactions to its
highest level and safeguard their business. Therefore, financial statement
analysis is prepared to predict the amount of expected returns to assess
the risks associated with those, returns to improve the firm's

7
performance. For the purposed, this study will tries to make financial
statement analysis to identify uses of financial analysis for performance
evaluate in bank of Abyssinia (BOA) (the companies bulletin 2009).

1.2. Background of Bank of Organization

February 15, 1906 marked the beginning of banking in Ethiopia when
the first Bank of Abyssinia was inaugurated by Emperor Menilik 11. It
was a private bank whose shares were sold in Addis Ababa, New York,
Paris, London and Vienna. One of projects financed by the bank in its
early years was the Franco-Ethiopia Railway which reached Addis Ababa
in 1917.

In 1931, Emperor Haileselassie introduced reforms into the banking

system and the Bank of Abyssinia became the Bank of Ethiopia, a fully
government owned bank providing central and commercial services with
the Italian innovation in 1935 came the demise of one of the earliest
initiatives in Africa banking.

On 15 February, 1996, ninety years to the day after the establishment of

the first Bank of Abyssinia, a new privately owned bank with this historic
name, but otherwise not connected with the older bank, came into
existence.

The subscribed capital of the new Bank of Abyssinia (BOA) was Birr 25
Million and its authorized capital Birr 50 Million with 131 shareholders,
all Ethiopians.

BOA's key objectives are: - Profitability, efficiency, market share,

dynamism, innovation, credibility, competitiveness and courtesy.

In just under three years of operation, BOA is giving evidence that these
objectives are being met.

8
Bank of Abyssinia's Service:
BOA currently offers the following standard service

Current (checking) accounts

Saving accounts

Time deposits

NR/NT accounts

Overdraft facilities

Term loans

Merchandise loans

Letters of credit

Forex bureau services

Guarantees

In addition to the above

BOA provides a late after noon services up to 5:00 P.M

It offers competitive rates to depositors, the most competitive in the
industry.

A customized BOA service offered to our town clients who need to
move funds quickly. Funds can be moved through telephone
instruction after the customer has gone through an identification
procedure.
BOA pays interest every month, not every six months, which is the
industry practice. This means that interest is compounded every month.

1.3. Statement of the Problem

Financial statement analysis is crucial for maintaining good judgment on
the financial position and future potential and risk associated with it.
Investors who purchase a company's stock expect that they will receive
dividends and that the stock's value will increase, creditors make loans
with the expectation of receiving interest and principal. Both groups bear
the risk that they will not receive their expected returns. They use

9
financial statement analysis to predict the amount of expected returns
and asses the risks associated with those returns.

If the financial statement is not analyzed and used efficiently it leads to

wrong decision. Due to this reason, users can not evaluate the position of
company, efficiency of operations, potential of investments, the credit
worthiness of borrowing, etc of a firm.

Therefore, it is important to analyze financial statements of the company

in order to determine financial position and performance evaluation.

1.4. Research Questions

The research try to answer the following research question:-

• How was the performance of the Bank for the past three years?
(from the year 2007-2009). Hence, this study was undertaken
based on the available documents up to the year 2009
• How is the bank in terms of its ability to pay its obligation?
• How is the profitability position of the bank over time?
• What are the financial strength and weakness of the firm?
• Does the firm use it's resource efficiently and effectively?

1.5. Objective of the Study

1.5.1. General Objective
The general objective of the paper is to investigate or review the
performance of bank of Abyssinia for the last three years.

1.5.2. Specific Objective

To assess the ability of the firm to meet it's short term
obligation.

To explore the trends in profitability of the company.

To assess the firm's financial strength and weakness.

10

To look in to how the firm use financial resources efficiently
and effectively.
1.6. Significance of the Study
The study of financial statement analysis is important for profit making
and not for profit making organization. Since Abyssinia Bank is a profit
making organization that gives service in expectation of getting profit and
brings their customer satisfactions to its highest level and safeguards
their business, this paper is important for the management to evaluate
the performance of the firm and help to make decisions based on
liquidity ratio and profitability of the company. It also can be used as a
reference for further study on the subject.

1.7. Scope of the Study

This study is limited to the analysis of a Bank of Abyssinia financial
statement which covers a period from 2007, 2008 and 2009. Under these
methods we used ratio, common size and trend for assessing the
performance.

1.8. Research Design and Methodology

1.8.1. Types of Research
Descriptive research is this type research employed through quantitative
research method.

1.8.2. Types of Data Used

The research has used secondary data sources from various bulletins
reports used by the bank regarding its financial performance.

1.8.3. Method of Data Collection

The researcher conducted to get required information on the secondary
data which are obtained from the reports.

11
1.8.4. Method of Data Analysis
Having collected the related documents of the three, years (2007- 2009),
from annual report bulletins and other documents, the researchers have
identified, collected and coded the financial data and accordingly put
them into tables describing year’s financial performance by the bank.
Having put these financial figures, the researchers have further
described it into graphs and ratios. Finally these figures have further
explained by words so that the reader could get meaning about the
figures and the ratio.

1.9. Limitation of the Study

When conducting this study, there were constraints of time, money and
to have access to data necessary for the study. Despite all these facts,
the researchers exerted the maximum effort to get valuable and valid
data to outshine or reflect the significance of the paper.

1.10. Organization of the Study

This research paper is organized into four chapters. The first chapter is
about the introduction part that includes, the back ground of the study,
background of organization, statement of the problem, objective of the
study, significance of study, scope and limitation of the study and
research methodology. Chapter two includes review of related literatures,
Chapter three is about data presentation and analysis based on annual
report from the company. Chapter four includes summary, conclusion
and recommendation.

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 CHAPTER TWO
LITERATURE REVIEW

2.1. Financial Statements

The end product of the accounting process is a set of financial
statements that portrays the company in financial terms. Each relates to
a specific date or covers a specific period of business activity, such as a
year. Managers and investors wants to know about a company financial
statements at the end of the period. Financial statements are intended to
enable outsiders to make decisions and to regulate profit distribution.
The contents of a business enterprise's financial statements have
significant economic consequences on the enterprise, its owners, its
creditors and all other parties who have an economic stake in its
financial strength and profitability. Financial statements that arc
relevant, complete, objective, timely and understandable are perceived by
users to be credible (Harrison and Horngren, 1998:15)

The published finance statements of a corporation consist of the balance

sheet, income statement, statement of cash flows, and accompanying
footnotes. A statement of retained earnings is also included with the
published financial statements, but it only explains the charge in the
retained earnings account on the balance sheet. In order to evaluate the
financial position or an entity it is necessary to understand these
statements and to be aware of their problems and limitations.

1. Balance Sheet: A balance sheet, also called statement of financial

position, presents the financial position of a business enterprise on a
specific date. A balance sheet provides a historical summary of assets,
liabilities and equity.
Assets: are probable future economic benefits obtained or controlled
by a particular entity as a result of past transactions or
events.

13
 Liabilities: are probable future sacrifices or economic benefits
arising from present obligations or a particular entity
to transfer assets or provide services to other entities
in the future as a result of past transactions or events.
Equity: Is the residual interest in the assets or an entity that
remains after deducting its liabilities. In a business
enterprise the equity is the ownership interest.

A balance sheet is basically a historical statement because it shows the

cumulative effective of past transaction and events. Generally, it is
described as a detailed expression f the basic accounting equation.

Assets = Liabilities + Owners' Equity

Assets are costs that have not been deducted from revenue; they
represent expected future economic benefits. However, the right to assets
has been acquired by a business enterprise as a result of past
transactions. If no future economic benefit is expected from a cost
incurred by the enterprise, the cost in question is not an asset and
should not be included in the balance sheet. Liabilities also result from
past transactions; they are obligations that require settlement in the
future, either by a transfer of assets or by the performance of services.
Implicit in these concepts of the nature of assets and liabilities is the
meaning of owners' equity as the residual equity in the assets of a
business enterprise (Mosich, 1989:167-168)

Equity Capital represents ownership capital as equity shareholders

collectively own the company. They enjoy the rewards and bear the risk
of ownership. However, their liability, unlike the liability of the owner in a
proprietary firm and the partners in a partnership concern is limited to
their capital contributions.

14
Authorized, issued, subscribed, and paid-up capital: the amount of
capital that a company can potentially issue, as per its memorandum,
represents the authorized capital. The amount offered by the company to
the investors is called the issued capital (Chandra, 1997.336)

Debt versus equity: To the extent that a firm borrows money, it usually
gives first claim to the firm's cash flow to creditors. Equity holders are
only entitled to the residual value, the portion left after creditors are
paid. The value of this residual portion is the shareholders' equity in the
firm, which is just the value of the firm's assets less the value of the
firm's liabilities.

Shareholders' equity = assets - liabilities

The use of debt in a firm's capital structure is called financial leverage.

The more debt a firm has (as a percentage of assets), the greater is its
degree financial leverage (Ross, 1998: 23)

Market Value versus Book Value: The values shown on the balance
sheet for the firm's assets are book values and generally are not what the
assets are actually worth. For current assets market value and book
value might be somewhat similar because current assets are bought and
converted into cash over a relatively short span of time. In other
circumstances, the two values might differ quite a bit. Moreover, for fixed
assets, it would be purely a coincidence if the actual market value of an
asset (what the asset could he sold for) were equal to its book value.
(Ibid)

2. Income Statement: An income statement is a summary of revenues

and expenses and gains and losses ending with-net income for a
particular period of time. The business and investment community
uses this report to determine profitability, investment value, and

15
 credit worthiness. It provides investors and creditors with information
that helps them predict the amounts, timing and uncertainty of future
cash flows. It helps users of financial statements predict future cash
flows in a number of different ways. First, investors and creditors can
use the information on the income statement to evaluate the past
performance of the enterprise. Second, the income statement helps
users determine the risk of not achieving particular cash flows.

Revenue is the inflow or other enhancement of assets of a business

enterprise or settlements of its liabilities (or a combination of both)
during an accounting period from delivering or producing goods,
rendering services, or other activities that constitute the enterprise's
ongoing major or central operations. Revenue generally results in
increase cash and receivables.

Expenses are outflows or other using up of assets or incurrence of

liabilities during an accounting period from the sale of goods or the
rendering of services.

Income is the residual of revenues which is expenses are deducted.

Income = Revenue – Expense

3. Statement of Cash Flows: The primary purpose of a statement of

cash flows is to provide relevant information about the cash receipts
and cash payments of an enterprise during a period. To achieve this
purpose and to aid investors, creditors, and others in their analysis of
cash, the statement of cash flows reports.
1. The cash effects of an enterprise's operations during a period,
2. Its investing transactions.
3. Its financing transactions, and
4. The net increase or decrease in cash during the period.

16
Reporting the source, uses, and net increase or decrease in cash IS
useful because investors, creditors and others want to know what IS
happening to a company's most liquid resource. The statement of cash
flows is therefore, useful because it provides answers to the following
simple but important questions:
1. Where did the cash come from during the period?
2. What was the cash used for during the period?
3. What was the change in the cash balance during the period?

Cash receipts and cash payments during a period are classified in the
statement of cash flows into three different activities:
1. Operating activities: Involve the cash effects of transactions that
enter into the determination of net income.
2. Investing activities: Include making and collecting loans and
acquiring and disposing of investments (both debt and equity) and
property, plant, and equipment.
3. Financing activities: Involve liability and owners' equity items
and include a) obtaining capital from owners and providing them
with a return on (and a return of) their investment and b)
borrowing money from creditors and repaying the amounts
borrowed (Kieso, 1992: 208-209)

2.2. Definition of Financial Statement Analysis

Financial statement analysis is the process of examining relationships
among financial statement elements and making comparisons with
relevant information. It is a valuable tool used by investors and creditors,
financial analysts, and others in their decision-making processes related
to stocks, bonds, and other financial instruments. The goal in analyzing
financial statements is to assess past performance and current financial
position and to make predications about the future performance of a
company (IM Pandy 1982:500)

17
2.3. Types of Financial Statement Analysis
Primary types of financial statement analysis are commonly known as
horizontal analysis, vertical analysis, and ratio analysis (IBID P: 208-209)

Horizontal Analysis
When an analyst compares financial information for two or more years
for a single company, the process is referred to as horizontal analysis,
since the analyst is reading across the page to compare any single line
item, such as sales revenues. In addition to comparing dollar amounts,
the analyst computes percentage changes from year to year for all
financial statement balances, such as cash and inventory. Alternatively,
in comparing financial statements for a number of years, the analyst may
prefer to use a variation of horizontal analysis called trend analysis.

Vertical Analysis
When using vertical analysis, the analyst calculates each item on a single
financial statement as a percentage of a total. The term vertical analysis
applies because each year's figures are listed vertically on a financial
statement. The total used by the analyst on the income statement is net
sales revenue, while on the balance sheet it is total assets. This approach
to financial statement analysis, also known as component percentages,
produces common-size financial statements. Common-size balance
sheets and income statements can be more easily compared, whether
across the years for a single company or across different companies (IBID
P: 209)

Ratio Analysis
Ratio analysis enables the analyst to compare items on a single financial
statement or to examine the relationships between items on two financial
statements. After calculating ratios for each year's financial data, the
analyst can then examine trends for the company across years. Since

18
ratios adjust for size, using this analytical tool facilitates intercompany
as well as intra company comparisons (IBID P: 209)

2.4. Purpose and Objectives of Analyzing Financial

Statements
A sound analysis of financial statements will be crucial for maintaining
good judgment on the financial position and future potential and risk
associated with it. Needless and Powers describes the objectives of FSA
as broadly as the following:-Creditors and investors as well as managers,
use financial statements analysis to judge the past performance and
current position of a company, and also to judge its future potential and
the risk associated with it. Creditors use the information gained from
their analysis to make reliable loans that will be repaid with interest.
Investors use the information to make investments that will provide a
return that is worth the risk. (Mosich, 1989:445)

• Past Performance and Current Position:

Past performance is a good indicator of future performance. Therefore, an
investor or creditor looks the trend of past revenues, expenses, net
income, cash flow, and return on investment not only as a means for
judging management past performance but also as a possible indicator of
future performance. In addition, an analysis of current position will tell,
for example, what assets the business owns and what liabilities must be
paid, It will also tell what the cash position is, how much debt the
company has in relation to equity, and what levels of inventories and
receivables exist. Knowing a company's past performance and current
position is often important in achieving the second general objective of
financial analysis.

19
• Future Potential and Risk Associated with it:
Information about the past and present is useful only to the extent that it
bears on decisions about the future. An investor judges the potential
earning ability of a company because that ability will affect the market
price of the company's stock and the amount of dividends the company
will pay. A creditor judges the potential debt-paying ability of the
company.

The risk of an investment or loan depends on how easy it is to predict

future profitability or liquidity.

Financial statement analysis is a judgmental process. One of the primary

objectives in identification of major changes (turning points) in trends,
amounts, and relationships and investigation of the reasons underlying
those changes. Often a turning point may signal an early warning of a
significant shift in the future success or failure of the business. The
judgment process can be improved by experience and the use of
analytical tools.

The interpretation and evaluation of financial statement data require

familiarity with the basic tools of financial statement analysis. The
accountant's function is twofold:
1. To measure economic events and transactions, and
2. To communicate economic information about them to interested
parties.

But communication in accounting means more than just preparing the

reports. Communication presumes understanding, and to promote
understanding accountants must also analyze and interpret financial
statements.

20
Analysis is used to find answers about the "why" questions in depth. In
looking at performance and present position the financial analyst seeks
answers to two questions. These are what is the company's earning
performance and is the company sound financial condition.
Erich A. Herfet (1991) states three objective of financial analysis
1. The interpretation of financial information: It involves
judgmental interpretation of the financial statements and other
financial data about a company for purposes of assessing and
projecting its performance and value.
2. The use of comparative data: Are the essential part of financial
analysis as they help put judgments about a particular company or
business in perspective.
3. Market analysis: Involves the study and projection of the pattern
of share prices of the company and its competitors relative to the
stock market trends.

It is here that financial analysis becomes a bridge between published

financial statement reporting accounting performance and market trends
reflecting the economic value of a company. The analyst focuses on the
value derivers behind the market value of the shares, which are basic
economic variables like cash flow generated relative cost effectiveness of
the business. (Ibid)

2.5. Problems in Financial Statement Analysis

Some or the problems and limitations of financial statement analysis is
discussed blow. The problems in conducting a FSA are Development of
comparative data, Seasonal/cyclical data distortions, differences in
accounting treatment and window dressing.

Developing and Using Comparative Data:- Many large firms operate a

number of different division in quite different industries and in such

21
cases it is difficult develop meaningful industry averages. This tends to
make FSA more useful for small firms with single product lines than for
large multi product companies. Additionally most firms want to be better
than average (although half will be above and half below the median). So
merely attaining average performance is not necessarily good (Harrison
and Horngren, 1998: 646)

Seasonal/cyclical data distortions:- inflation has badly distorted firms

balance sheets. Further reported profits are affected because past
inflation affects both depreciation charges and the cost of inventory
include in the cost of good sold. Thus a FSA for one firm over time or a
comparative analysis of firms of different ages which use different
accounting methods must be interpreted with caution and judgment.
(Ibid)

Differences in accounting treatment:- different accounting practices

can he distort ratio comparisons. For e.g. there are four commonly used
inventory valuation methods: SI, FIFO, LIFO and W A during inflationary
periods. LIFO produces a higher CGS and a lower EI valuation than do
the other methods of course no problem would occur if firms being
compared used the same accounting policies. Fortunately, most firm's in
a given industry normally do use similar procedures. Other accounting
practices can also create distortions like non capitalized lease.

Window dressing:- Firms sometimes employ window dressing to make

their financial statements look better to analysts. If a company record
checks received as cash but it record checks written as current liabilities
other than as deductions from cash. And also firms may resort to
window dressing to project a favorable financial picture. E.g., a firm may
prepare its balance sheet at a point when its inventory is very low. As a
result it may appear that the firm has a very comfortable liquidity
position and a high turnover of inventories. When window dressing of

22
this kind is suspected, the (Financial Analysis) FA should look the
average level of inventory over a period of time and not the level of
inventory at just point of time.

Financial statement analysis is limited on several dimensions. GAAP and

its underlying accounting conventions and measurement rules and
principles, present some limits. Managers often have the ability to select
favorable accounting methods. They can make choices as to the timing
for reporting favorable or unfavorable results. A close reading of the
notes may indicate where some of these choices have had an impact on
the financial ratio. However may of these managerial choices will not be
revealed to external users of financials statements. Investors, in
particular, must rely on independent accounts assessment of the
suitability of management's accounting choices.

A second major limitation of financial statement analysis concerns the

"what's missing factor. Many major factors affecting profitability and
survival of the firm are just not included in accrual accounting not in the
financial statement.

A third concern in financial statement analysis that "real" events are

often hard to distinguish from the effects of alternative accounting
methods or principles. By focusing more on cash flow the investor or
other analyst can identify cases where financial reports based on accrual
accounting may diverge from the cash flows or inducted reflect other
pertinent economic events.

Fourth and final limitation of financial statement analysis concerns

predictable. The past may not be a reliable indicator of the future. Stable
trends may be reversed tomorrow; financial statements are just one of
the important inputs that the investor must use as a basis for investing
decisions. (F. Brigham, 1996: 639-641)

23
2.6. Financial Ratio Analysis
Ratio analysis is the, starting point in developing the information desired
by the analyst. Financial ratios are usually expressed in percent or
times. These are designed to help one evaluate a financial statement.
Financial ratios are ways of comparing and investigating the relationship
between different pieces of financial information. Also it shows the
financial strengths and weaknesses of the financial performance of a
firm. To evaluate a firm's financial condition and performance, the
financial analyst needs to perform "checkups" on various aspects of a
firm's financial health. (James C-Van Horne, 1998:132)

2.6.1. Nature of Financial Ratio Analysis

Ratio analysis is a powerful tool of financial analysis .A ratio is defined as
"the indicated quotient of two mathematical expressions" and as "the
relationship between two or more things" In financial analysis, a ratio is
used as a benchmark for evaluating the financial position and
performance of a firm. For example consider current ratio. It is calculated
by dividing current assets by current liabilities: the ratio indicates a
quantified relationship between current asset and current liabilities. This
relationship is an index or yardstick which permits a qualitative
judgment to be formed about the firm's ability to meet its current
obligations. It measures the firm's liquidity. The grater the ratio, the
grater the firm's liquidity and vice versa. (Pandey, 1996:104)

2.6.2. Types of Financial Ratio Analysis

Generally companies could present comparative or percentage (common
size) analysis. In comparative analysis the same information is presented
for two or more different dates or periods so that like items may be
compared. Absolute figures or ratios are close to being meaningless
unless compared to another figure. One must have a guide to determine
the meaning of ratios and other measures that are computed. Several

24
types of comparisons offer insight into the financial position. Using the
past history of firms for comparison is trend analysis. By looking at a
trend in a particular ratio, one sees whether that ratio is falling, rising, or
remaining relatively constant. From this problem is detected or good
management is observed. The other comparison is using industry
averages and comparison with competitors. The analysis of an entity's
financial statements can be more meaningful if the results are compared
with industry average and with result of competitors. (Pandey, 1981:502)

Generally, financial ratios are grouped into five categories.

2.6.2.1. Liquidity Ratios

Liquidity Measure of Short-term solvency ratios are intended to provide
information about a firm's liquidity. The primary concern is the firm's
ability to pay its bills over the short run without undue stress.
Consequently, these ratios focus on current assets and current liabilities.
Liquidity ratios are particularly interesting to short-term creditors.
Because financial managers are constantly working with banks and
other short-term lenders, an understanding of these ratios is essential.
(Ibid)

One advantage of looking at current assets and liabilities is that their

book values and market values are likely to be similar.
There are two commonly used short-term solvency (liquidity) ratios:

1. The current ratio: is defined by dividing current assets by current

liabilities.

Current ratio = Current assets

Current Liabilities

25
Current assets normally include case, marketable securities, accounts
receivable, and inventories. Current liabilities consists of accounts
payable, notes payable, current maturities of long term debt, accrued
taxes, and other accrued expenses. This ratio tells that the ability of the
firm that will be able to cover the liabilities. (Ibid)

2. The Quick (or Acid-Test) Ratio: inventory is often the least liquid
current asset. It is also the one for which the book values are least
reliable as measures of market value, because the quality of the
inventory is not considered. The quick ratio could be defined as:

Quick, or acid test ratio = Current assets – inventories

Current liabilities
2.6.2.2. Activity Ratio
Activity rations, also called asset management or turnover ratios,
measure how effectively the firm is managing and utilizing its assets.
They indicate how much a firm has invested in a particular type of asset
relative to the revenue the asset is producing.

These ratios are designed to answer this questions: does the total
amount of each type of asset as reported on the balance sheet seem
reasonable, too high, or too low in view of current and projected sales
levels.

These ratios focus on the sales and the inventory, the fixed assets, days'
sale outstanding and the total assets. Ratios included in this category
are:

The Inventory Turnover Ratio: shows how rapidly the inventory is

turning into receivable through sales. It is described by:
Inventory turnover ratio = Cost of sold
Average inventory

26
Average inventory can be computed as: Beginning + Ending Inventories
2

And also if cost goods sold is not available inventory turnover can be
Computed as: Inventory ratio = Sales
Average inventories

The Fixed Assets Turnover Ratio: This ratio indicates the extent to which
a firm is using existing property, plant and equipment to generate sales.
It is the ratio of sales to net fixed assets.
Fixed assets turnover ratio = Sales
Net Fixed Assets

The Total Assets Turnover Ratio; Measures the turnover of all the firm's
assts. It indicates how effectively firm uses its total resources to generate
sales and is a summary measure influenced by each of the asset
management ratio.
Total assets turnover ratio = Sales
Total Assets

The Days Sales Outstanding (DSO): Also called the average collection
period is used to appraise accounts receivable. It is the average number
of days an account receivables remain outstanding. It represents the
average length of time that the firm must wait after making a sale before
receiving cash, which is the average collection period. (Ibid)
DSO = Receivables Receivables
Average sales per day Annual Sales /360

2.6.2.3. Financial Leverage Ratios

It is also termed as long-term solvency measures or debt management
ratios. These ratios are intended to address the firm's long-run ability to
meet its obligations, or, more generally, its financial leverage. These
ratios are of interest primarily to bondholders who need some indication
of the measure of protection available to them. In addition, they indicate

27
part of the risk involved in investing in common stock. The more debt
that is added to the capital structure, the more uncertain in the return
on common stock, there are two types of financial leverage ratios:
component percentage financial and coverage ratios. Component
percentages compare a company's debt with either its total capital (debt
plus equity) or its equity capital. Coverage ratio is reflect a company's
ability to satisfy fixed obligations such as interest, principal, repayment,
lease payments. (Ibid)

Component Percentage Financial Leverage Ratios

The component percentage financial leverage ratios convey how reliant a
company is on debt financing. These ratios compare the amount of debt
to either the total capital of the company or to the equity capital.

1. Debt to Total Assets: The ratio provides the creditors with some
idea of the corporation ability to withstand losses without
impairing the interests of creditors. From the creditor's point of
view a low ratio of debt to total assets is desirable. The lower this
ratio is the more 'buffer' there is available to creditors before the
corporation becomes insolvent.

Debt to total assets = Total Debt

Total Assets or Equity

1. The long term debt to assets ratio: indicates the proportion of

the company's assets that are financed with long term debt.
Long term debt asset ratio = Total debt
Total assets

2. The debt to equity ratio: indicate the relative uses of debt and
equity as sources of capital to finance the company's assets
evaluated using book value of the capital sources. (Ibid)

28
 Total debt to equity ratio = Total debt
Total shareholders equity

Coverage Financial Leverage Ratios

In addition to leverage ratio that use information about how debt is
related to either assets or, there are a number of financial leverage ratios
that capture the ability of the company to satisfy its debt obligations.
There are many ratio that accomplish this, but the two most common
ratios are the time interest coverage ratio and the fixed charge coverage
ratio.

Times interest coverage ratio: Measures how well a company has its
interest obligations covered and it is called the interest coverage ratio.
This ratio is computed by:

Times interest coverage ratio = Income before interest and taxes

Interest charges

The fixed charge coverage ratio expands on the obligations covered and
can be specified to include any fixed charges, such as lease payments
and preferred stock dividends.
Fixed charge coverage ratio = Earnings before interest and taxes + lease payment
Interest + lease payment

Coverage ratios are often used in debt covenants to help protect the
creditors.

2.6.2.4. Profitability Ratios

Profitability ratios indicate how well the enterprise has operated during
the year. These ratios answer such questions as was the net income
adequate? What amount was earned by different equity claimants?
Generally, the ratios are either computed on the basis of sales or on an

29
investment base such as total assets. Profitability is frequently used as
the ultimate test of management effectiveness.

Profit Margin on Sales:

Computed by dividing net income by net sales for the period:

Profit margin on sales = for the period.

Profit margin on sales = Net income

Net sales

Rate of Return on Assets: is a measure of profit per dollar of assets. It

is computed by dividing net income by total assets.

Rate of Return on Assets = Net income

Total assets

Rate of Return on Common Stock Equity: Is a measure of how the

stockholders fared during the year. Because benefiting shareholders is
the goal of the firm, in accounting sense it is the true bottom line
measure of performance.

Return on Equity = Net Income

Total Equity

2.6.2.5. Market Value Ratios

A final group of ratios is based on information not necessarily contained
in financial statements, the market price per share of the stock.
Obviously, these measures can only be calculated directly for publicly
traded companies.

Price/Earnings Ratio: Shows how much investors are willing to pay per
dollar of reported profits.

30
 Price/Earnings Ratio = Market price per share
Earnings per share
Market/Book Ratio: The ratio of a stock's market price to its book value
gives another indication of how investors regard the company.

Market / Book Ratio = Market price per share

Book value per share
Price/Earnings Ratio: shows how much investor is willing to pay per
dollar of reported profits.
Price/ Earnings Ratio = Market price per share
Earnings per share

Market/Book Ratio: The ratio of a stock's market price to its book value
gives another indication of how investors regard the company.
Market/ Book Ratio = Market price per share
Book value per share

Companies with relatively high rates of return on equity generally sell at

higher multiples of book value than those with low returns.

Earnings per share: The earnings per share figure is one of the most
important ratios used by investment analysis. If no dilute securities are
present in the capital structure, then earnings per share is simply
computed by dividing net income minus preferred dividends by the
average number of shares of outstanding common stock. If, however,
convertible securities, stock options, warrants, or other dilute securities
are included in the capital structure, earnings per common and common
equivalent shares and fully diluted earnings per share figures may have
to be used.

Earnings per share = Net income - preferred dividends

Average shares outstanding

31
Dilute securities are 'securities that, although they are not common
stock inform, enable their holders to obtain common stock upon exercise
or conversion (Pandey, 1981:502)

2.6.3. Standards of Comparison

The ratio analysis involves comparison for a useful interpretation of the
financial statement. A single ratio in itself does not indicate favorable or
unfavorable condition. It should be compared with some standard.
Standards of comparison may consist of:

2.6.3.1. Trend Analysis

It is the easiest way to evaluate the performance of a firm is to compare
its present ratios with the past ratios. When financial ratios over a period
of time are compared, it is known as the trend (or time series) analysis. It
gives an indication of the direction of change and reflects whether the
firm's financial performance has improved, deteriorated or remained
constant over time. The analyst should not simply determine the change
but, more importantly, he/she should understand why ratios have
changed. The change for example, may be affected by changes in the
accounting policies without a material change in the firm's performance.

2.6.3.2. Industry Analysis

To determine the financial condition and performance of a firm, its ratios
may be comparing with average ratios of the industry of which the firm is
a member. This sort of analysis, known as the industry analysis, helps to
ascertain the financial standing and capability of the firm vis-a-vis other
firms in the industry. Industry ratios are important standards in view of
the fact that each industry has its characteristics which influence the
financial and operating relationships (Pandey, 1999: 110-111)

32
2.6.3.3. Common Size Analysis
Percentage (common size) analysis consists of reducing a series of related
amounts to a series of percentages of a given base. All items in an
income statement are frequently expressed as a percentage of sales; a
balance sheet may be analyzed on the basis of total assets. This analysis
facilitates comparison and is helpful in evaluating the relative size of
items or the relative change in items. A conversion of absolute dollar
amounts to percentages may also facilitate comparison between
companies of different size. Common size analysis could be vertical
analysis or horizontal analysis (Kieso, 1992: 1361-1362)

2.6.4. Use of Financial Ratios Analysis

Ratio analysis is used by three main groups:
1. Managers who employ ratios to help analyze, control and thus
improve their firm's operations.
2. Credit analysts, including bank loan officers and bond rating
analysts, who analyze ratios to help ascertain a company's
ability to pay its debts;
3. Stock analysts, who are interested in a company's efficiency,
risk and growth prospects. Ratio analysis can provide useful
information concerning a company's operations and financial
condition and it involves the methods of interpreting financial
ratios to assess the firm's performance and status. The basic
inputs to ratio analysis are the firm's income statements and
balance sheet for the periods to be examined (Brigham,
2005:463-464)

33
2.6.5. Limitations of Financial Ratio Analysis
A ratio can be computed precisely, it is easy to attach a high degree of
reliability or significance to it. The reader of financial statements must
understand the basic limitations associated with ratio analysis when
evaluating an enterprise.

As analytical tools, ratios are attractive because they are simple and
convenient. Frequently decisions are based on only these simple
computations involving relationships between financial data. The ratios
are only as good as the data upon which they are based and the
information with which they are compared (Kieso, 1992: 1384-1385)

One important limitation of ratios is that they are based on historical

cost, which can lead to distortions in measuring performance. By failing
to incorporate changing price information, many believe that inaccurate
assessments of the enterprise's financial condition and performance
result (Kieso, 1992: 1384-1385)

34
 CHAPTER THREE
DATA PRESENTATION, ANALYSIS AND INTERPRETATION

Under this section the student researchers have gathered the financial
data from the different sources of information put in black and white by
the bank. Having collected the financial data they have analyzed in view
of the literature review depicted in chapter two.

3.1. Financial Statement Analysis of BOA

As we can understand from different fiscal years’ annual report, bank of

Abyssinia uses different graph and charts contain figures and percentage
to compare and contrast year to year trends. Based on this, the
researchers use ratio analysis to evaluate the financial performances of
different fiscal periods. It is used to interpret the financial statement so
that the strength and weakness of a firm as well as its historical
performance and current financial condition can be determined. The
following financials ratios are computed as follows.

3.1.1. Liquidity Ratio

As the year to year trends indicate that the liquidity position of BOA can
say strong, i.e. the liquid asset of the bank in relation to the net current
liabilities stood at 43.4% at the end of June, 2007. This is substantially
higher than the minimum rate of 15% set by the NBE. Further more, the
ratio of capital to risk weighted assets of the bank stood 13.5% (as
indicated in Appendix 10) at the end of the fiscal year 2007. As compared
to the required minimum capital adequacy ratio of 8% set by the
supervisor Authority.

35
 Risk Management Report
Description 2006 2007 2008 2009
Current asset 1,014,059,680 1,339,310,508 1,637,398,474 2,956,238,709
Current liability 2,612,436,106 3,175,212,704 3,849,866,780 4,957,396,033
Current ratio 0.39% 0.42% 0.43% 0.60%

Current Ratio
Current ratio is the ratio of current asset to current liability
Current ratio = Current assets
Current liabilities

Table 1. Analysis of Current Ratio

Description 2007 2008 2009
Current asset 1,339,310,508 1,637,398,474 2,956,238,709
Current liability 3,175,212,704 3,849,866,780 4,957,396,033
Current ratio 0.42% 0.43% 0.60%
Source: BOA Financial Statement

The above table shows that the bank’s current ratio showed slight
increase from 2007 to 2008 by 0.01% and also highest increase in 2009
by 0.17%. This indicates that the firm is liquid has the ability to pay
bills. On the other hand, a relatively low value of the current ratio in
2007, but this is not considered as an indication that the bank will find
difficulty in paying bills because liquidity position of the bank is
minimum of 15% Set by the National Bank of Ethiopia.

Cash Ratio
Cash ratio is a ratio of cash equivalent plus marketable security to
current liability. It indicate the firm’s ability to pay current liability if for
some reason immediate payment were demanded.

Cash Ratio= Cash Equivalent (CE) + Marketable (MKT) security

Current liability

36
Table 2. Analysis of Cash Ratio
Description 2007 2008 2009
CE + MKT security 822,003,596 1,442,646,414 2,696,293,802
Current liability 3,175,212,704 3,849,886,780 4,957,396,033
Cash ratio 0.26% 0.37% 0.54%
Source: BOA Financial Statement

Graph 1 Compare Current Ratio and

cash Ratio

1.2
1
0.8
Current Ratio
0.6
Cash Ratio
0.4
0.2
0
2006.5 2007 2007.5 2008 2008.5

Fig. 3.1. Current and Cash Ratio (Liquidity Ratio)

As the above given table and graph show, the company’s cash ratio
increased from 2007 up to 2009 at rate of 0.11% and 0.17% respectively.
The conventional rule says that the company has cash ratio above
standards i.e. 8%. It implies that the liquidity position is strong to satisfy
short term obligation by cash. This is because of increase in current
liabilities than cash.

3.1.2. Activity Ratios

Activity ratio or asset management ratio indicate the efficiency with
which firm manages and used it’s asset. The amount of sales generated
and the obtaining of the profit depend on the efficient management of
this asset by the firm. These activity ratios are also known as “efficiency
ratio” because they indicate the speed with which assets being converted
or turned over in sales. Ratios that analyze different types of assets are
described as follows:

37
3.1.2.1. Fixed Asset Turnover Ratio (FATOR)
As it was stated in chapter two FATOR indicate the extent of capacity
utilization in the firm’s properly plant and equipment to generate
revenue.
FATOR = Total Sales
Net Fixed Assets
Table: 3. Fixed Asset Turnover Ratio
Description 2007/08 2008/09 2009/10
Total sales 266,687,844 347,446,002 404,812,945
Net fixed assets 41,311,701 65,971,079 77,639,375
FATOR 6.46% 5.27% 5.21%
Source: BOA Financial Statement

The above table shows that the ratio of sales to fixed assets has
decreased with the rate of 1.19% and 0.06% times respectively. A high
fixed assets turnover ratio recorded in year 2007. This indicates efficient
utilization of fixed assets in sales, while a low ratio in 2009 recorded
compared to the previous two years. But the two consecutive years have
indicated that there is lag behind in the performance of FATOR.
Therefore the firm properly used plant and equipment to generate
revenue has been lower through the years indicated.

3.1.2.2. Total Asset Turnover Ratio (TATOR)

TATOR measures the overall performance and efficiency of the business
enterprise. It points out the extent of efficiency in the use of assets by the
firm.

It is calculated by dividing the annual sales value by the value of total

assets.

TATOR = Total Sales

Total Assets

38
Table: 4. Total Asset Turnover Ratio
Description 2007 2008 2009
Total Sales 266,687,844 347,446,002 404,812,945
Total Assets 3,577,964,010 4,269,946,935 5,476,625,540
TATO 0.074% 0.081% 0.074%
Source: BOA Financial Statement

Graph 2 Compare FATOR and TATOR

8
7
6
5
4 FATOR
3 TATOR
2
1
0
2006 2007 2008 2009 2010

Fig. 3.2. Activity Ratios

The above table and graph show that the company’s TATOR ratio has
slightly increased from 2007 to 2008 by the rate of 0.007 and in 2009
decreased by 0.007 times. The total asset turnover ratio shows the firm’s
ability of generating sales from all the financial resources committed to
the firm.
As this ratio increases, there is more revenue generated per total
investment in assets.

3.1.3. Profitability Ratio

Profitability ratios are calculated to measure the profitability of the firm
and operation efficiency. Profitability is the net result of a number of
policies and decisions. But the ratios go on to show the combined effects
of liquidity, asset management and debt on operating results.
Profitability ratios are calculated to measure the profitability of the firm
and operation efficiency.

39
3.1.3.1. Net Profit Margin (NPM)
The first profitability ratio in relation to sales is the net profit margin
(simply gross margin). It is calculated by dividing net income by sales.

Net Profit Margin = Net income

Sales
Table:5 Net Profit Margin
Description 2007 2008 2009
Net income 66,300,800 16,655,459 100,367,944
Sales 266,687,844 347,446,002 404,812,945
NPM 25% 5% 25%
Source: BOA Financial Statement

The analysis implies that the bank’s NPM from 2007 to 2008 decreased
by 20% as compared to year 2007 and in 2009 increased by 20% as
compared to 2008. Where as the least is recorded in 2008 which is 5%,
the higher net profit margin is desirable but the banks ratio indicates
lower profit margin, which means the bank’s management is inefficient
in generating income from the sales activity, yet a variety of other factors
that are extraneous could be attributed along with this. The net income
increase or decrease because of the expense appeared in the year.

3.1.3.2. Basic Earning Power Ratio (BEPR)

It is calculated by dividing earning before interest and taxes (EBIT) to
total assets.

BEPR= EBIT
Total Asset
Table: 6.Basic Earning Power ratio
Description 2007 2008 2009
EBIT 155,471,297 115,310,940 257,466,491
Total Asset 3,577,960,010 4,269,946,935 5,476,625,540
BEPR 4.3% 2.7% 4.7%
Source: BOA Financial Statement

40
The analysis implies that BEPR slightly deceased from 2007 to 2008 by
1.6% as compared to year 2007/2008. In year 2008 lower percentage
recorded because of operating expenses is too large in 2009 increased by
2%. The ratio measures operating income resulting from the bank
investment in total asset.

3.1.3.3. Return on Total Assets (ROA)

The ratio of net income to total assets measures the profitability per birr
invested in assets. It is computed as the ratio of net income to total
assets.

ROA = Net Income

Total Assets
Table: 7. Return on Total Asset
Description 2007 2008 2009
Net income 66,300,800 16,655,459 100,367,944
Total asset 3,577,964,010 4,269,946,935 5,476,625,540
ROA 1.9% 0.4% 1.8%
Source: BOA Financial Statement

The above table shows that the ROA from 2007 to 2008 decreased by
1.5% respectively in 2009 compared to 2008 increased by 1.4%, a lower
ROA recorded in 2008 compared to year 2007/2008 this happened
because of the occurrence of high expense incurred. The percentage
indicates that the bank net profit generated per birr invested in total
assets. In 2008 and 2009 profitability of the bank decrease due to
inefficient use of its assets. This implies that the bank’s performance in
this regard in the year has fallen behind as compared to the previous
years. Hence, lower ROA has been recorded.

41
3.1.3.4. Return on Equity (ROE)
Ultimately the most important or “bottom line” accounting ratio is the
ratio of net income to shareholder equity (SHE).

ROE = Net Income

Shareholder equity

Table: 8. Return on Equity

Description 2007 2008 2009
Net income 66,300,800 16,655,459 100,367,944
SHE 404,751,306 420,080,155 519,229,507
ROE 16% 4% 19%
Source: BOA Financial Statement

Graph 3 Compares NPM, BEPR, ROA

and ROE

5
4.5
4
3.5 NPM
3 BEPR
2.5
2 ROA
1.5 ROE
1
0.5
0
2007 2007 2008 2008 2009 2009 2010

Fig. 3.3. Profitability Ratio

The above table and graph show the ratios declined through the year
from 2007 to 2008 decreased by 12% and slightly increased 15% in 2009
compared to year 2007/2009 and also in 2008 drastically decreased to
4% from year 2007/2009. This is a result of increase in capital than net
income this implies that the profitable per birr invested by share holder
is lower.

42
3.1.4. Coverage Ratio
The interest coverage ratio is the sum of net profit before interest and tax
divided by interest charges.
Interest Coverage = EBIT
Interest Charge

Table: 9. Coverage Ratio

Description 2007 2008 2009
EBIT 155,471,297 115,310,940 257,466,491
Interest Charge 60,490,965 93,403,514 112,066,716
Interest Coverage 2.57% 1.23% 2.30%
Source: BOA Financial Statement

As shown in the above table, the interest coverage ratio decreased in year
2008 by the rate of 1.34 respectively, in 2009 increase by 1.07, a lower
ratios in 2008 indicate excessive use of debt compared to year
2007/2009. The interest coverage ratio shows how many times the
interest charges are covered by funds that is ordinarily available to pay
the interest charges.

3.1.4.1. Debt to Asset Ratio (DTAR)

The ratio of total debt to total assets is called debt ratio it measures the
percentage of funds provided by creditors. It is calculated using the
following formula:
DTAR = Total Debt
Total Asset

Table: 10. Debt to Asset Ratio

Description 2007 2008 2009

Total Debt 3,175,212,704 3,849,866,780 4,957,396,033
Total Asset 3,577,964,010 4,269,946,935 5,476,625,540
DTAR 0.89% 0.90% 0.91%
Source: BOA Financial Statement

43
Debt ratio shows the proportion of assets that are financed with debt, in
all years 2007 to 2009 highest ratio was recorded. This indicates most of
bank’s capital is financed by debt. The higher ratio means that claims
creditors are greater than those of owners. In all years more than 85% of
its capital is financed by debt.

3.1.4.2. Debt to Equity Ratio (DTER)

The debt to equity ratio is the measure of the relative claims of creditors
and owners against the firm’s assets. It is calculated in terms of:
DTER = Total Debt
Shareholder Equity
Table: 11. Debt to Equity Ratio
Description 2007 2008 2009
Total debt 3,175,212,704 3,849,866,780 4,957,396,033
Share holder Equity 402,751,306 420,080,155 519,229,507
DTER 7.88% 9.16% 9.54%
Source: BOA Financial Statement

The above ratio indicates the relative uses of debt and equity as source of
capital to finance the bank assets in 2007 to 2009 increased by the rate
of 1.28 and 0.38.

In addition to this the highest debt to equity recorded in 2009. This

indicates there is proportional of debt in it’s capital high. This is also
coverage ratio is shown graphically as follows:

44
 Graph 4 Compares DTAR, DTER and
Coverage Ratio

12
10 Interest
Coverage
8
DTAR
6
4
DTER
2
0
2006 2007 2008 2009 2010

Fig 3.4. Coverage Ratio

3.2. Common Size Analysis

Common size financial statements express each item of the balance sheet
and profit and loss statements as a percentage of total assets and total
income respectively. Thus, all balance sheet items are divided by total
assets and all profit and loss statement items are divided by total
income, in this regard, the following table 12 and 13 provide common
size financial statements of balance sheet and income statement of BOA.

45
Table 12: Common Size Balance Sheet (all Numbers in Percentage)
Description 2007 2008 2009
Cash and bank balance
Cash on hand 3.58 7.62 11.18
Deposit with local commercial bank 0.01 0.03 0.28
Deposit with foreign bank 7.27 6.91 6.85
Reserve account with NBE 3.63 10.42 11.05
Other accounts with NBE 8.47 8.80 19.88
Total cash 23.00 33.80 49.20
Item in course of collection from other bank 3.34 2.34 2.40
Deposits and prepayments 0.24 0.24 0.19
Loans and advances to customer 61.4 60.1 44.6
Treasury bills 5.59 - -
Other assets 0.20 1.95 2.15
Customer liabilities on letter of creditors per 5.08 - -
contra
Lease hold land - 0.01 0.01
Deffered expenditures - - 0.02
Intangible fixed assets 0.03 - -
Tangible fixed assets 1.21 1.53 1.39
Total assets 100 100 100
Liabilities deposit 2007 2008 2009
Demand deposits 14.28 18.39 22.12
Saving deposits 53.05 56.47 55.69
Fixed time deposits 8.72 6.58 4.26
Total time deposits 76.05 81.44 82.07
Margin held on letter of credit 0.09 1.80 1.63
Other liabilities 5.84 6.74 6.00
Provision for tax 0.79 0.17 0.82
Banks liabilities of letter of credit per contra 5.08 - -
Total liabilities 88.73 90.15 90.52
Capital and reserves - - -
Paid up capital 7.41 7.32 5.72
Share premium - 0.06 0.01
Legal reserve 2.08 1.84 1.90
Special reserve 0.37 0.31 0.47
Retained earnings 1.39 0.29 1.34
Total share holders 11.25 9.82 9.44
Total liabilities and share holders fund 100 100 100
Source: BOA Financial Statement

46
The above table shows financial statements was a relatively easy to read
and compared. Just looking at the three year balance sheet of BOA, in
the total assets column the coverage cash compared to other current
asset higher which is 23%, 33.8%, 49.2% percentage of total assets
respectively in the three year and relatively a lower ratio recorded in the
items of deposits and prepayments which is 0.24%, 0.24%, 0.19%
percentages of total assets. The liability section recorded a highest ratio
in saving deposits recorded above 50% and relatively a lower ratio
recorded in the provision for tax which is less than 1% recorded through
out the year. Lastly in the equity section recorded. The equity in slightly
decrease from 2007 by the rate of 11.25%, 9.82% and 9.44%
respectively.
This entails that each year has an increase in current asset and which
has its positive intent in the asset side, with lower deposit which
indicates the bank didn’t perform well in this regard.
Table 13: Common Size Income Statement (all Number In
Percentage)
Description 2007 2008 2009
Interest income 75.57 72.65 68.15
Commission income 3.06 3.39 3.31
Provision no longer required - - -
Gain on fluctuation of exchange 12.67 15.25 16.94
rates
Service changes foreign and local 5.53 5.54 5.55
Other income 3.16 3.16 6.05
Total revenue 100 100 100
Expense categories - - -
Interest expense 22.68 26.88 27.68
Salaries and benefits 11.90 13.03 16.28
General and administration 11.19 12.28 16.13
Board of directors 1.05 0.07 0.06
Audit fee 0.04 0.03 0.02
Provision for receivables - 0.31 0.03
Provision for daubto loans and 17.53 41.09 3.86
advances
Total expense 41.70 66.81 36.40
Source: BOA Financial Statement

47
In the above table the bench mark is sales. For a given period, each item
in the income statement is restated as a percentage of sales in the
analyses the highest percentage of sales recorded in the revenue section
items of interest income which is above 65% and correspondingly in the
expense section interest expense is the higher compare to other expense
the total expense section higher recorded in 2007 and 2008 which is
42%, 0.67% respectively.
This entails that interest expense has been a driving motive instead of
other expenses.

3.3. Common base year financial statement:

Trend analysis standardize financial statement that span several years
by selecting base year. Usually, the first year will be taken as abase year.
For the analysis of BOA year 2007 is taken as abase year. The following
two tables show the trend analysis of income statement and balance
sheet of the bank. Then express individual items or accounts as a
percentage of the base year value of the item.

48
Table 14: Common Base year Balance Sheet
Description 2007 2008 2009
Cash and bank balances
Cash on hand 100 253 477
Deposit with local commercial bank 100 341 364
Deposit with foreign bank 100 113 144
Reserve account with NBE 100 342 465
Other accounts with NBE 100 125 359
Items in course of collecting from 100 84 109
other bank
Deposits and prepayment 100 113 115
Loans and advances to customer 100 116 115
Other assets 100 1180 1675
Customers liabilities on letter of 100 - -
credits per contra
Intangible fixed assets 100 - -
Tangible fixed assets 100 161 187
Total assets 100 119 153
Liabilities
Demand deposits 100 153 237
Saving deposits 100 127 160
Fixed time deposits 100 90 74
Margin held on letter of credit 100 221 257
Other liabilities 100 137 157
Provision for tax 100 25 158
Bank’s liabilities of letter of credit 100 - -
per contra
Total liabilities 100 121 156
Capital and reserves
Paid up capital 100 117 118
Legal reserve 100 105 139
Special reserve 100 100 193
Retained earnings 100 25 147
Total share holders 100 104 128
Total liabilities and shareholders 100 119 153
fund
Source: BOA Financial Statement

In the above table financial statements are relatively read and compared
based on the base year to compete how much percent is increased and
decreased. We see same item from the balance sheet of the asset section
takes, cash on hand increase by 153 percent from 2007 to 2008. Deposit

49
with local commercial bank increased through out the year specially in
the year 2008 and 2009 a highest percent increased by 241% and 364%
respectively and also other assets a higher percentage increase in 2008
and 2009. In the liability section all deposits through the three year
increase its percentage and other liability account also increase. Lastly in
the equity section higher percentage recorded in the legal reserve and
paid up capital accounts, a least recorded in the retained earnings
accounts specially in year 2008.

Table: 15. Common base year Incomes Statement: Trend

Description 2007 2008 2009
Interest income 100 125 136
Commission income 100 144 163
Gain on fluctuation of exchange 100 156 202
rates
Service changes foreign and local 100 130 152
Other income 100 130 290
Total revenue 100 123 141
Expense categories
Interest expense 100 154 185
Salaries and benefits 100 142 207
General expense 100 142 218
Provision for doubtful loans and 100 305 33.45
advances
Total expense Analysis 100 208 132
Source: BOA Financial Statement

50
Revenue Analysis
The above table compares the percentage change by taking the base year
how much increase and decreased the income statement items compared
with the base year to the other two year. In the revenue section the
interest income of the bank increased throughout the year compared to
base year as a percentage of 25% and 36% and also other income
increased by 30% and 190% respectively in the year. In the overall
income category the BOA registered in 2009 high operating income of
birr 404,812 million exhibiting an increase of 17% or birr 57million
compare to 2008. This implies the interest income has increased and
this has been depicted over the4 entire year and the overall high
operating income.

Trend in Income
Interest Income
350
300
Comision Income
250
200
Gain on Fluctuation of
150 Exchange Rates
100
Service Changes
50 foreign and Local
0
Other Income
2006 2007 2008 2009 2010

Figure 3.5. Trend in Income

Expense Analysis
In the expense section the interest expense of the bank increase through
out the year compare to base year as a percentage of 54% and 85% and
also salaries and benefits increased by 42% and 107% respectively in
the year. Generally the total expense of the bank in 2009 stood at birr
259.4million this amount compared to 2008 declined by birr 66million

51
(20%) due to a substantial reduction in the provision for loans and
advances for reporting period.

Trends in Expense
Interest Expense
350
300
250 Salaries and
200 Benefit
150 General Expense
100
50
0 Provision for
2006 2007 2008 2009 2010 Doubtful Loans
and Advances
Figure 3.6. Trend in Expense

52
 CHAPTER FOUR
SUMMARY, CONCLUSIONS AND RECOMMENDATIONS
In this part the summary of the findings in figures listed above in each
section of the measures will be considered and further summarized for
convenience and further understanding.

4.1. SUMMARY OF FINDINGS

 The current rations in the three consecutive years show that an

increment above 40%. This indicates that the liquidity position of the
bank is strong compared to the minimum requirement of 15% set by
the National Bank of Ethiopia (NBE).
 When we observe the operational performances of the bank, more or
less it is efficient in using its assets to generate more sales or in come,
even if, some of its assets are sitting idle.
 The earning power ratio shows a slight decrease from 0.043 to 0.027
in the year 2007 and 2008. Then after, in the fiscal year 2009 it
increases to 0.047. In 2008 there was a drastic change in decreasing
the basic earning power of the bank due to increasing (boosting) of
operating expenses.
 BOA debt ratio shows that the larger part of its capital is financed by
debt rather than shareholders equity. i.e. more than 85% of debt
financing has been used by the bank in its capital structure.
 Some developments are registered in BOA’s income accounts in the
year 2008/09 due to a decline in its total expense. In the same fiscal
year (2008/2009) the total expense of the bank is declined by 20%
from the previous period.

53
4.2. Conclusions
The researcher has come to conclude the following:-
• The current ratio of the company for most of the research years
under the study are shows an increment above 40%. This implies
the firm is liquid has the ability to pay bills especially in year 2007
a relatively low value of the current ratio but this is not consider as
indication that the bank will find difficulty in paying bills because
liquidity position of the bank is minimum of 15% set by the
national bank of Ethiopia.
• When we observe the operational performances of the bank, a high
fixed assets turn over rations recorded in year 2007. This indicates
efficiency in utilizing fixed asset, and a low fixed asset turn over
ratio reflects in efficient uses even if, some of its assets are sitting
idle. In general we can conclude that the company is utilizing its
fixed asset efficiently.
• The earning power ration shows a slight decrease from the year
2007 to 2008. This implies operating expense is too large. In 2008,
there was a drastic change in decreasing the basic power of the
bank due to increasing operating expense. Then after in the fiscal
year 2009 it increases by 2%. This implies basic early power ratio
is in a good condition.
• The debt ratios of the company for the three consecutive years are
greater than 85%. This shows the firm dominated by the out siders
fund and displays its weak financial contribution by the share
holder. This shows the contribution of out side debt is highly
greater than that of owner’s contributions.
• The profitability of the bank increases from year to year, even if
there are same fluctuations in the area of utilization of some
company’s assets and equities. This implies the company is in a
positive progress interms of profit.

54
 Recommendations
The researchers listed some suggestions or recommendations for the
company based the researcher finding and conclusions.
 One of the most important issues that needs a due attention is the
claim of creditors is greater than owners. This means BOA debt ratio
shows that the larger amount of its assets are financed by debt. In
short, debt financing is greater than equity financing. So the company
should minimize its debt and rely on self financing.
 When we observe the distribution of the bank’s loans and advances by
different economic sectors denotes that the domestic trade and
services took the lion’s share by contributing 28% of the total loan
portfolio, but it gives less attention to the agriculture sector. Which is
4% in the fiscal year 2008/2009? But as we know, agriculture is the
backbone of the national economy, hence, BOA should create better
loan or credit opportunities to those who invest in agriculture sector.
 The other important issue that needs much concentration is using of
technology. If the bank uses our currently updated technologies such
as payment card system, developing its own software in large, it can
register better achievement or results than the previous periods
(years).
 The management should also give the emphasis to its profitability. It
may work to words enhancing profitability by reducing costs and
expense.
 In addition, the company has a potential to generate income by using
the same fixed asset and administration expense, so it should
increase its income by making other business.

55
 BIBLIOGRAPHY

Chandra, Prasanna, (1997). Financial Management. 4th ed. Tata

McGraw-Hin Publishing Company.
F. Brigham, (1996). Intermediate Financial Management. 5th ed, Tata
McGraw-Hin Publishing Company
Harrison and Horngren, (1998). Financial Accounting. 3rd ed. John
Wiley and Sons, Inc. New York.
IM Pandey, (1999). Financial Management. 8th ed. New Delhi, Tata
McGraw-Hill Company.
Kieson, (1992). Financial Accounting. John wiley and Sons, Inc. New
York.
Mosich, A.N. (1989). Intermediate Accounting. 5th ed. McGraw-Hill
Book company.
Ross, Wester Frield, Jordan, (1998). Fundamentals of Corporate
Finance. 3rd ed. Tata McGraw-Hill Company Limited of west Pate
Nagar, New Delhi.
Van Harne, Wachowicz, Fr. (1998). Fundamentals of Financial Management.
India (Manufactured) only in India.

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 DECLARATION

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