FINANCIAL STATEMENT ANALYSIS AS A BANK LENDING TOOLS
THE DEFINITION OF FINANCIAL STATEMENT ANALYSIS
In a broad sense, financial statement analysis involves determining the levels of risk and expected returns of individual financial assets as well as group of financial assets. For example financial statement analysis involves both individual common stock, such as I.B.M, groups of common stock, stock such as the computer industry’s or on an even larger basis, the stock market itself.
In this case, financial statement analysis would result in a decisional how to split the investor’s money between the stock and bond markets as well as a decision of whether to buy or sell computer stock in general and IBM in particular.
The financial analysis handbook defines analyst as synonymous with security analyst or investment one who analyze securities and makes recommendations statement analysis can be viewed as the activity of providing inputs to the port folio management process. For some, the image of a typical financial analyst is that of a game, fully equipped with green eyeshade, poring over financial statement in a back room. Though the physical description is rarely accurate, it is true that many analyst do study financial statement in an attempt to predict the future.
- THE MEANING AND IMPORTANCE OF BANK LENDING
Hommby defined lending “as giving temporary use of
something”, Mayer (1975) see lending as “the use fo money to bring time”.
Lending involves give something for a period of time on the understanding than it or its equivalent will be returned.
Bank lending has to do with an extension of loans (money) to a borrows. As stated by Parry (1975) “A bank leads money to a pre-analyzed limited principally by overdraft loan or personal loans”. Whichever from the lending assumes it expected to be recovered after the specified period.
According to Mayer this lending is over a period of time. These loons are extended for specified period of time after which the sum is expected to be recovered.
In a well run financial institution like bank, no more than one third of one percent of the loans are supposed to go bad and agreement which is to be signed, and endorsed by the lending bank and the borrows therefore usually proceeds lending. First the borrower must agree to report his business results to the bank at regular intervals preferable with a certificated statement by his accountable access to all his books and records and must agree not to borrow money form other source without the consent of the bank.
He must also agree to provide evidence of insurance on the business and on himself sufficient to repay the bank if anything happens to it form the words of Whilt Lessey.(1952 – 290) “show one a bank that has quit lending money and I will show you a bank that is due to fail.
Kennedy (1958) has this to say “A financial institution that does not lend money is not a bank in the true sense of the word’.
Lending is an importance aspect of banking, it is further captured in the words of Roussaris (1977) while bank offer a wide spectrum of financial services, direct lending is their main a natural advantage by tradition and organization.
The bank equally gets some values through this lending activity. This happens through an announcement that the bank has been chosen instrument in arranging financial for a huge project. Bank credit has also seen to the development and growth of many small size business that would have otherwise withered and died. Lending also helps in creating and maintaining good deposit relationships.
Banks lending activities greatly influence economic development by increasingly determining the ratio between consumption and investment. Bank lending grants recognitions to troubled companies. A distressed company gets a lot of values form an announcement that a big banks has given it a item of credit.
- OBJECTIVE OF BANK LENDING
The commercial objective of bank is to maximized profit,
although other social and economic function tend to deflect bank from profit maximization as their primary objective.
(Osuanyanata 1986), he also noted that the principal lending objective of a bank includes growth, profitability and liquidity.
GROWTH
For any lending decision and activity to be wroth the effort, there must be enough assurance that it will lead to the banks business growth in terms of an additional variety of services yielding good income to the bank.
It should also increase the available quantity of banks loans resources. If from the beginning, the lending carries fro greater risks than are considered reasonable, it is likely that it could turn bad at a future date and therefore fails to contribute to bank’s loan resources quality wise.
PROFITABILITY
Bank lend where the profit rate to high, risk or replacement small and lost of administering loan low” according to Osuyanah (1986) “As profit is necessary for the long term survival of the firm and since profitability is used as an index for possessing managerial performance.
It is natural that most company’s management would consider return on investment as a prime objective.
He further says that in lending activity, the loan since it present a check of deposited money and a source of income to the bank. No lending is attractive if the expected income is less than the average cost of borrowed funds.
LIQUIDITY
Certain safety measurement exist to ensure that bank’s liquidity is reasonable maintained. The control mechanism cash reserves ratio and liquidity ratio.
The purpose of a loan and its implications on the company are therefore given due consideration before it is undertaken. There are three basic principles of lending and it is further broken down into other factors which must be considered when granted a loan and which can be described as the connons of lending.
Inspite of al the myriad of controls, guidelines and regulations in respect of bank in (Union Bank) bank have to exercise care and prudence in their lending activities.
When a bank is approached for a loan, it should obtain satisfactory answers to some basic questions which includes: –
- how much the customer want to borrow
- why the customer wants bank finance
- how he wants it
- how financially strong the borrows business is to ensure continuity of his plans suffer a set back
- what security he can offer
- the banks assessment of the customer in (1989) Perry note, the canons of lending as
- how much is required
- BASIC PRINCIPLE OF LENDING
Marsh (1988) has it to say “that while lending cannot be
regarded as a science, that is it cannot be broken down into a fool proof mathematical formular to meet all situation, there are basic principles which understand all lending proposition”.
Mather (1972) compares the principal of lending to economic laws in that certain factors another things being equal, a prescribed course should follows, they are neither independent nor unbreakable.
Mother (1972) sues the three basic principles behind all bank lending as safety, profitability and suitability.
SATEFY
The safety of any loan is a para-important to the bank. The safety of the loan depend upon both the willingness and ability of borrower to meet loan obligations as they feel due.
Bearing this in mind, the personal characteristics of a customer deserves through evaluation. At time of repayment a customer might have the money in his possession and still not pay up. Bank will therefore lay great emphasis on the character, integrity and reliability of borrows. Osuyanah (1986) sees it as the three of credit character capacity and capital” there must be a reasonable certainty that the amount granted can be repaid form profits and cash flow generated.
In support of the safety requirement the borrower must be able to provide acceptable security which will serve as something to fall back on if the expected source of repayment should fail.
PROFITABILITY
It is a well know fact that banks are business oriented mainly to make profits and not a charitable organization. Therefore, it follows that any loan granted is expected to yield some profits for the bank
SUITABILITY
The bank should also satisfy about the suitability an advance. Even where the requirement of a borrower satisfies all safety and risk considerations. It is absolutely necessary for a bank to ensure that the purpose of the loan is not in conflict with the economic and monetary policies of government.
“In Nigeria, bank lending is highly regulated and controlled by the Central Bank”.
- purpose of loan
- for how long are the fund required
- what to the source of repayment
AMOUNT
There is a tendency for customer the amount to ask for the amount they think the bank will lend rather than the figure they consider realistically needed to see a project through.
The customer is expected to be able to determine fairly accurately know much finance he requires. He should therefore submit a cash budget to the bank. Osuyanah (1988) says that “it important in assess whether the amount being sought will be adequate to satisfactorily carryout the venture”.
Palfrenan (1988) is of the opinion that it is important to calculate at the onset the maximum amount required as you do not wish to be faced with a request for increased facilities in a crisis situation at later date”.
There is no point for the bank to grant a maximum amount which is inadequate to finance the project the customer cannot contribution to the project is very important.
According to Palfreman (1988) “when the question of amount is being considered, it is important for you to relate the amount is being considered, it is important for you to relate the amount that the bank is being asked for, to the amount which the customer is contributing to the venture”.
The borrower’s contribution to the project must be reasonable as it is one of the ways the banker can determine the borrower’s commitment. The higher the borrower investment, the greater will be his determination to succeed and make profits.
PURPOSES OF LOAN
It must be emphasized that knowledge of the purpose of what the loan is to be used to very important. “A bank would not advance money to finance an illegal or fraudulent project”. According to Holden (1961), certain government controls exists, which they make it impossible to grant a particular advance”.
Some venture are completely banned by the government and are not expected to be carried out by any bank. A bank for instance will not lend to finance quantity, bottling and speculation since the government frowns at it.
SOURCE OF REPAYMENT
It is a standard rule of banking that if the bank cannot see how the customer can repay advance, he must not lend, even if adequate security is available.
The source of repayment is very vital. The money to be lend is not for the bank but belongs to depositor. Repayment will therefore be the heart of any proposition before a part. The bank will be more inclined to lending. The customer can demonstrate how and when repayment will be made.
No bank wants a loan to cry scandalize into hardcore borrowing.
Consequently, the source of repayment is of upper most importance to the bank.
STRENGTH OF THE BUSINESS
The bank needs to ascertain this by carefully analyzing the financial statement of the borrowers. After the analysis, the bank should be in a position to determine the inherent strength and weakness of the company and whether the company is strong enough to keep going or if the plans should suffer a set back
SECURITY
Security should not seen as the source of repayment but only expected to ready on, if, the expected source of repayment fails.
The ability of a borrower to produce tangible security is not the most important criteria, for granting loans and the offer of security does not weaken the need for a through examination of the proposal.
This however does not go to mean that security is unimportant
According to Perry (1983) says “it serves as a buffer against unforeseen advance development. Security should normally be obtained as an additional leverage to the bank for its advance because, in Nigeria were some borrowers position do sometimes a change quickly (Osuyanah, 1986).
Loan however, are not to be made just because they are secured. The real security for any advance is the character of the borrower. The bulk of bank lending lies on trust and faith in the customer and his business.
Cox on his theory (1990) stated that although every lending proposition should stand by itself that is, it should be good enough not to need security manager often asks for suitable securities form the customer in case of advance should go wrong”.
Securities are readily converted into cash and the market value must be greater than the value of the loan it secured (Adusaki’s 1972).
Security for advance will thus consist of a valuable item deposited with a bank to support the amount being borrowed and confirm the borrowers willingness to repay the loans it is realizable item he exercise produce in managing the loan in order not to forfeit the valuable item.
Cox (1990) says “there are three main requirement of any security acceptable to a bank:
- it should be easy to value
- it should be easy for the bank to obtain a good legal title.
- It should be readily marketable or realizable. The great emphasis that has been placed on security as a canons or good lending, creates a major problem to sound lending decision making by union banks.
LAND
Land is perhaps the moist widely accepted security for bank advance in union bank”. (Osuyanah 1986). One to be age long additional ownership of land, the average Nigeria borrower would like to loose his rights over the assets to a bank if he can help it.
On obvious advantage land has over others that is, it tends to appreciate in value over time, “land has the advantage of permanency and cannot be lost or physically moved (Toft 1987).
Notwithstanding, the attractions which land commenced as security, it has some drawbacks. “Land is not easily marketable and a forced sale is apt to result in a price very much below the normal one (Onuchaya 1981).
Cox 1990, things that land is much difficult to value than stocks and shares over a period of time, most land and property rise in value especially that of a type for which there is a steady demand.
Although it may be difficult to exercise the sale of land particularly if it is located in an obscure place. The realization could be better if it is located in a prime area.
According to Kelly (1984), “properly is an easy security to realize especially if it is need a preparation so an income statement. The income statement according to Toft (1986) is designed to show the direct cost of trading that is, the cost which vary with the amount of goods purchase and sold.
BALANCE SHEET
Kirkman (1977), “The balance sheet is rather like a photography of a rail way train which don’t normally reveal any thing about the speed of the train if it is moving and the direction to which it is traveling.
Osuyanah (1986), viewed it as a snap-short of the financial statement of the company as at a particular date”.
Cooper (1989) in his opinion says that balance sheet is a statement that shows the affairs of business at a point in time. The balance sheet looks at the state of a business at a particular moment of time usually the end of financial year quite distant from the income statement.
According to Cox (1990) “the balance sheet is into an account but is does not form part of the double entry book keeping system, at a given date”. It can be seen as sap-short taken of the business at an instant time, however, the next day it can rather be different statement of changes in financial position present the source and application of funds that the firm if it is domestic home occupied by the mortgager and his family. Report to the courts is then usually necessary in order to obtain a possession order.
Despite the disadvantage of land as security, it is favoured among other types of securities. As captured on the words of Kelly (1984) land can always be used productively (to growth food) unlike other securities” (stock & shares).
Theses are equally used as security for bank lending company shares can either be quoted or unquoted. While quoted shares are those listed on the Nigerian stock exchange, unquoted ones related to private shares that are not listed on the stock exchange and are therefore often difficult to value.
Omalaya (1981) noted, “stock and shares is public companies
are good securities for bank lending or loan provided they have been quoted on the stock exchange as major factor which ought to have been considered are merely glossed over. Securities though of insufficient value to pay off the loan provide there functions (Mayer 1975)”. They are as follows.
LEVERAGE: – As long as the borrowers remains in business, the equipment and machinery necessary for his business operation are important. The fact therefore, that these equipment have been used as insurance given greater incentive to the borrower to meet payment.
COLLATERAL CONTROL: – A security agreement if taken prevent s the applicant from obtaining an additional loan from another lending institution.
LOSS REDUCTION: – When a loan is default, security can be sold and proceeds applied towards the loan balance. Some of the securities accepted for bank loans includes:
- land
- stock and share
THE BORROWER
The customer to whom loan is to be extended must pass the test of reliability, personal, integrity and honesty (Adekanye 1986).
It is important for bank to know a customer very well and be able to judge the customer’s ability intelligence and his business experience. The financial statement of the borrower can also throw some light on the borrowers performance.
SECURITY FOR BANK LOAN
The general principal guiding a prudent banker’ demand for security could be derived form the owners to the following questions.
When everything fails what does the bank have? Can the bank afford to watch loan beneficiaries perish with bank’s funds? How will be bank accounts for this loss to depositors and share holders?
(Enyinanya 1992).
Security is normally required by bank move as an insurance against unknown events which may render the proposal loan repayment place difficult. Security is normally obtained as an additional leverage to the bank for its advance.
According to Toft (1986), security is a safeguard against unforeseen problems with an advance as an insurance designed to protect the bank and its depositor.
- CONSTRAINTS OF LENDING
Bank’s ability to grant loan is often affected by some factors
which includes internal and external factors.
- INTERNAL CONSTRAINTS
Deposit Base: – One of the constraints of lending is the
volume of bank deposits base. If there is an appreciable increase in deposits, there will then be more loan able funds to meet the requires of various borrowing customers. On the other hand, if there is low deposited base, kindly will intend to be low. Most Nigerian banks therefore try to improve their deposit base.
Any drop in the level of savings will pose a great threat to the lending volume that can be achieved.
LIQUIDITY REQUIREMENT
The liquidity ratios prescribed by the central bank creates a limitation on the quantity of loan. According to Pal Freman (1988). The higher the liquidity ratio the lower the total amount of loan which can be granted on a given value of deposits”. The appropriation of funds to meet the liquidity requirement curtails the aggregate of deposits available for lending purposes.
SHARE HOLDER’S FUND
For the protection of bank’s capital base so that it is not over lent, there exist a direct relationship between shareholder’s fund, deposits and the extent to which loan can be granted.
Again this poses a constrain on loan granting unless the shareholder’s base is made more realistic.
- EXTERNAL CONSTRAINTS TO LENDING
Since lending objectives are designed to ensure growth and
profitability, the economic environment determines the growth and profit opportunities than can be taped. If an economy is depressed, every bank lends to protect first and for most, its loan portfolio.
INTER INDUSTRY PERFORMANCE
Performance indicates base on inter-industry comparison might pose a constraint in lending. If the risks and the prospects and opportunities, the bank is more likely to channel its resources to the industry that shows greater promise.
2.4 FINANCIAL STATEMENT AND ITS USEFULNESS
financial statement constitute the income statement balance sheet and statement of charges in finical position, Fadeji (1992).
INCOME STATEMENT
According to Kirikman (1977), the income statement is a statesman that provides the prospective credit or with a limited amounts of valuable information regarding sales and profitability trend. Cox (1990), said that income statement shows all the expenses of the business for the year and deducting it from the gross profit to give net profit.
According to Chinson (1922), “An income statement is a summary of revenues and expenses and gains and losses ending with net income for particular period of time. The income statement is an integral part of the financial statement and as fear as profit and loss is concerned it present details information. It present the revenue and expenses account for the purpose of determining the profitability of the enterprises during a particular amounting period.
The income statement is quite useful. According to Osuyanah (1986), the organization or nay trading to assess the performance result over loss”. There is thus guarantees.
According to Osuyanah (1986) it is a statement showing information that assist in determining whether the management of the company has use the resources which come into his control during they era to the great advantage”.
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