IMPACTS OF RATIO ANALYSIS ON INVESTMENT DECISION IN THE BANKING SECTOR OF NIGERIA

ABSTRACT

The study examined impact of ratio analysis on investment decision in banking sector in Nigeria, a case study of three selected commercial banks in Lagos State. A well-constructed questionnaire, which was adjudged valid and reliable, was used for collection of data from the respondents. The data obtained through the administration of the questionnaires was analyzed using the Pearson correlation analysis.

The results showed that there is positive and significant relationship between ratio analysis and investment decision in the selected commercial banks in Nigeria (r=0.772; p<0.05). The results were found to be consistent with empirical findings of past studies in literature.

The study concludes that that there is significant relationship between Total Ratio Analysis variables and Number of Shares Traded (NOST) in the banking sector of Nigeria. This is in line with ratio analysis being significant with investment decision.

Based on the findings of the study, the study recommends that; Ratio analysis, should be employed by the financial management of every bank, to ensure that bank’s assets are safeguarded, cash inclusive; Finance, accounting department should be established in every bank, which should be headed by a qualified accountant; The bank management should be used to a particular ratio which has been more beneficial to them; The bank management should be observant when it comes to investing, they should always be certain of the return, and timing period is very necessary.

 

 

 

 

 

 

 

CHAPTER ONE

INTRODUCTION

1.1  Background to the Study

In every organization, regardless of its size and structure, ratio analysis plays a crucial role in decision making. Ratio analysis is a tool used to analyze the financial performance and position of a company and it means different things to different people i.e. it is computed by different users for different reasons (Usman Mohammed, 2004).  Amina Haji Nkuhl (2015) defined ratio analysis as the judgmental process which aims at evaluating the current and past financial positions and results of an entity the primary objectives of determining the possible best estimate. Investment decision was defined by Omolumo (2000) as the means of allocating fund to invest proposals whose benefits are to be realized in the future. The fundamental statements or accounts to be analyzed by stakeholders who intend to compute ratios are the statement of comprehensive income, statement of financial position, statement of cash flows and statement of changes in financial position (Amina Haji Nkuhl, 2015)

Amina Haji Nkuhl (2015) also suggested that investors use information from financial statements to test if the company they are about to invest in will be able to meet up with its objective as the primary objective of every firm is to increase its shareholders wealth either through the payment of dividends or through the increase in the market value of the company’s shares. The financial statement is usually expressed in monetary terms and analyzed by a financial manager employed in the case of a company or even an individual who wants to invest in a company (Amina Haji Nkuhl, 2015). The analysis of financial ratios computed by the financial manager shows the operating and financial efficiency and growth of a firm and also determines the ability of the firm to meet its obligations, the extent to which the firm has used its long term solvency from borrowed funds and the overall operating efficiency and performance of the firm. The job of a financial manager is therefore, very important as his responsibilities involves identifying and appraising the viability of available investment using various techniques, deciding on the appropriate way to finance the chosen investment and also determining how much to be paid as dividend to the company’s shareholders (Usman Mohammed, 2005).

As a result of economic hardship and inflation in the economy, it becomes very important to adopt a very effective and reliable means of evaluating the performance of companies for investment decisions by investors, management, shareholders, creditors and even the general public (Dr. Adeghe, R. & Atu, O. K, 2015).  Financial ratio analysis is important to analysts, therefore, ratios are intended to provide meaningful relationship between individual values in the financial statement (Reilly, Brown, 2006). It makes sense to provide a vast number of potential ratios because a single number from the financial statement is of little value unless it is compared to ratios of other entities. A firm’s performance can be relatively compared by an aggregate economy, by its industries or by its past performance (Reilly, Brown, 2006). As with all ratios, a comparison with other firms in similar industries is useful, and a comparison of these ratios for the same firm from period to period is important in pinpointing trends and changes. It is also important to keep in mind that these ratios are interrelated and should be examined together rather than independently.

Studies have shown that ratio analysis could influence investment decision making. Usman Mohammed (2005) expressed that financial ratios are calculated from financial statements prepared by an accountants which, to an extent influenced investment decisions of common stock holders either to maintain their stock in the company, reduce their stock or disinvest in the company. Usman Mohammed (2005) also stated that of all the tools of financial analysis, ratio analysis is the most widely used because the level of the historical trends of ratio analysis can be used to make inferences about a company’s financial condition, its operations and attractiveness as an investment. Helfert (1997) (as cited in Andabai, P. W & Egoro, S. A, 2017) argued that, comparing the ratios for several successive years and observing for especially favorable ends, ratio analysis might provide the important early warning signals that allows for the solving of business problems before it becomes too late. Finally, it must be emphasized that ratios must be compared with some prevailing standards because it cannot in itself, convey any meaningful and useful result.

1.2  Statement of the Problem

As the main objective of every organization is to maximize their shareholders wealth through the payment of dividend and the increase in the market price or value of their shares (Amina, Haji Nkuhl, 2015). Investors also have a part to play in ensuring that this objective is achievable through the decisions they make regarding the companies they invest their resources (Abdulrasq Abdullahi, 2009). Investors are provided with the financial statements to evaluate performance before making these decisions but, the performance of a company cannot be measured through mere looking at the financial statement, analysis like ratios have to be computed in order to properly understand the financial statement and make good decisions that will benefit the investor and increase shareholders wealth.

Many potential investors, shareholders and other users of the financial statement are unable to analyze the financial statement of companies because of their lack of knowledge and understanding in financial statement analysis. Some of them employ a financial analyst to help them out but sometimes it is not always certain if the necessary disclosures made in the financial statement is misleading or not (Amina, Haji Nkuhl, 2015). According to Onyekwelu (2010) as cited in Anaja, B. and Onoja, E. E. (2015), one of the most difficulties facing the auditing profession is that no auditing process can provide absolute assurance in the detecting of all fraudulent financial reporting. According to Duru (2012), this led to a believe that the annual financial statements of have failed in its responsibility to provide the credible information needed for investors and other uses of financial statements.

After making initial and conscious investment decisions, majority of the existing shareholders tend to use cash dividend and interest paid to evaluate the performance of companies for investment decisions instead of computing ratios (Dr. Adeghe, R. & Atu, O. K. 2015). Cash dividend and interest paid are just mere figures in financial statements which cannot be used to evaluate the worthwhileness of investing in a company. Ratio analysis has been stated to be one of the most powerful tools used for financial analysis but the difficulty of choosing the right ratios to be computed when analyzing the financial statement becomes a burden for investors and other users of the financial statements (Usman Mohammed, 2005).

These stated problems tend to threaten both the existing and potential investor while making investment decisions. And as a result of these problems, the research will examine the impact of ratio analysis on investment decision making.

1.3  Objectives of the study

The primary objective of this research work is to evaluate the impacts ratio analysis on investment decisions in the banking industry of Nigeria.

Specifically, the objective of this study are to examine the impacts of:

  1. Price earnings on the number of shares traded in the banking sector of Nigeria.
  2. Dividend Yield Ratio on the number of shares traded in the banking sector of Nigeria.
  3. Debt to Equity Ratio on the number of shares traded in the banking sector of Nigeria.
  4. Return on Shareholders’ Equity on the number of shares traded in the banking sector of Nigeria.
  5. Net Profit Margin on the number of shares traded in the banking sector of Nigeria.

1.4  Research questions

The following research questions will guide the study

  1. To what extent would Price Earnings Ratio influence the number of shares traded in the banking sector of Nigeria.
  2. To what extent would Dividend Yield Ratio the number of shares traded in the banking sector of Nigeria.
  3. To what extent would Debt to Equity influence the number of shares traded in the banking sector of Nigeria.
  4. To what extent would Return on Shareholders’ Equity influence the number of shares traded in the banking sector of Nigeria.
  5. To what extent would Net Profit Margin influence the number of shares traded in the banking sector of Nigeria.

1.5   Research hypotheses

In an attempt to answer the research questions the following hypotheses have been developed. The hypotheses are stated in alternative and null forms as follows:

 

H1: There is a significant relationship between Total Ratio Analysis variables and Number of Shares Traded (NOST) in the banking sector of Nigeria.

H0: There is no significant relationship between Total Ratio Analysis variables and Number of Shares Traded (NOST) in the banking sector of Nigeria.

1.6  Scope of the study

The scope of this research will be restricted to three banks which are United Bank of Africa, Zenith Bank and Diamond Bank plc.

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1.7  Significance of the study

This study will be of immense benefit to potential investors, shareholders, creditors, bond holders and other stakeholders like the government, employees, students, lecturers, stockbrokers, managers etc. as it would help them in decision making. The findings of this study will help in guiding the future actions of various stakeholders of a company.

The finding of this study will help potential investors who want to invest to see the potential probability, long term stability, dividend policy and potential growth of the of the company in order to make effective investment decisions. The study will also reveal the extent to which shareholders are influenced by financial ratios when making investment decisions.

The findings of this study will also help creditors make effective decisions by checking the  liquidity of the organization which means the ability of the organization to settle its debts and obligations by paying for goods and services as at when due, paying interest and repaying the principal sum on loans obtained.

The government will benefit from the findings of this research because they rely on ratio analysis like the liquidity and profitability ratios to determine and assess companies for tax purposes. The interest of the employee is how well their welfare can be improved which is determined by the long term stability and survival because their jobs depends greatly on it.

So as to provide a more comprehensive view of the financial position and performance of the organization, financial analysis is performed with the information obtained from the financial statements. The managers are primarily concerned with the profitability, efficiency, performance evaluation, internal control and management of assets of the business.

1.8  Limitations of the study

Research studies on ratio analysis is usually based on a large number of firms but due to time constraint, this study will be based on only two selected banks in Nigeria for a period of seven years (2010-2016). This study will be limited to the use of quoted companies because most small or medium scale enterprises in Nigeria do not publish their financial statements and are unwilling to release them which is constraint to the availability of data.

1.9  Operationalization of variables

Operationalization of variable is defined as the creation of a model for research variables. The relationship and model employed for this study is given as follows

            Y=f(X)

y= Dependent Variable

Y=NOST

X= independent Variable

x1= PER

x2= DYR

x3= DER

x4= ROSE

x5= NPM

To capture investment decisions, the number of share traded was employed, while to capture ratio analysis, Price Earnings Ratio, Dividend Yield Ratio, Debt to Equity Ratio, Return on Shareholder’s Equity and Net Profit Margin was employed.

            NOST = f (PER, DYR, DER, ROSE, NPM)

Where

NOST = Number of Shares Traded

PER = Price Earnings Ratio

DYR = Dividend Yield Ratio

DER = Debt to Equity Ratio

ROSE = Return on Shareholder’s Equity

NPM = Net Profit Margin      

1.10          Definition of key terms

Ratio: Mathematically, Ratio refers to the relationship that exists between two or more variables. According to Pandey (2005), ratio is “the indicated quotient of two mathematical expression” and as “the relationship between two or more things”.

Ratio Analysis: Amina Haji Nkuhl (2015) defined ratio analysis as the judgmental process which aims at evaluating the current and past financial positions and results of an entity the primary objectives of determining the possible best estimate

Financial analysis:  this is the selection, evaluation and interpretation of financial data contained in the financial statement along with pertinent information, to assist in investment and financial decision making. (Pamela Peterson Drake, 2005)

Financial Statement: A financial statement is a detailed report that shows the management performance, financial performance, position and cash flows of a business for a specific period. (Prince Casmir Idekwulim, 2014)

Statement of Financial Position: This can be defined as a statement that shows the financial wealth of a business. Basically, it shows the summary of an entity’s assets, liabilities and equity for a given period. (Prince Casmir Idekwulim, 2014)

Statement of Profit or Loss and other Comprehensive Income: This reports a company’s financial performance over a period of time. It shows the profit earned or loss incurred and income and expenses that occurred during a period. (Prince Casmir Idekwulim, 2014)

Statement of Cash flows: This statement shows how changes in statement of financial performance and position affect cash and cash equivalents and breaks the analysis down to operating, investing and financing activities. (Prince Casmir Idekwulim, 2014)

Investment Decision: investment decision can be defined as a firms decision to invest in its current funds efficiently in long-term assets whose benefits are anticipated to be realized in the future. (Amina Haji Nkuhi, 2015)

Investors: Investors are people who commits capital in order to gain financial returns.

Price Earnings Ratio: This ratio evaluates if stock is over or under priced. It reveals how many times the capital value of a business is higher than its current level of earnings and measures the level of confidence the market have in the future of the business.

PER = Market price per share

      Earnings per share

 

Dividend Yield Ratio: This ratio measures the percentage of the return through dividends when compared to the price paid for the stock or the cash returns from share to its market value.

 

DYR= Dividend per share

          Market price per share

 

Debt to Equity Ratio: This ratio measures the financial risk exposure level of a business. It also measures the amount of a company’s capital is financed by debt.

DER = Total liabilities

      Total shareholders fund

 

Return on Shareholders’ Equity: This ratio measures the percentage of returns on ordinary shareholders’ investment based on a period’s performance.

ROSE = Net profit

              Total Shareholders’ Equity

 

Net Profit Margin: This ratio measures the proportion of the sales revenue that is earned as profit after deducting all expenses excluding interest and tax.

NPM = Net profit     x 100%

       Revenue

Number of Shareholders: This refers to the amount of people that legally owns one more shares in a company for a period.

 

 

 

 

 

 

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