1.1 BACKGROUND OF THE STUDY:
Bank lending is concerned with provision of funds for needy customers as loans from the savings of the fund surplus units paid into the bank. Due to the established fact that the saved fund is at the disposal of the bank for specified period, the bank can thus provide these funds to their customers who may have greater use for these funds at the time.
The reason behind bank lending is the need to attain some economic growth through lending to already existing businesses for expansion and to individuals with entrepreneurial prospects to set up businesses and for making profit by far one of the most services provided by banks. It is the corner stone of a bank. Great care thus has to be exercised in this activity.
In the lending by banks, some lending policies should be adhered to, some questions should be addressed regarding:
Judgment in lending is the real test of a bank’s skill and as such the health of the business and not just the customer should be of a great interest to the bank. Banks suffer great losses following the non-payment of loans. Banks should develop carefully into an analysis and use of the financial statements before lending. This analysis involves the assessment of a company’s or borrower’s past; present and anticipated future financial condition that could lead to future problems and to determine any strength that the company/ borrower might capitalize on.
The tools for the financial statement analysis are the financial ratios which can be used to answer some important questions regarding a company’s/ customer’s well-being.
Such very important questions regarding are:
The answer to these questions in two words are RATIO ANALYSIS.
According to UBAKA (1996), ratio is defined as a useful tool with which to analyse a set of financial statements. It is the only such tool available to accountants to analyse a set of financial statements. Ratio is the arithmetic relationship between two figures in a set of financial statement. It can be presented in a number of forms. The particular form of presentation chosen for any relationship examined is the one which the analyst can best interpret, for instance, some people prefer to look at the periods, while others prefer percentage presentation.
The three basic financial statements which form the bedrock from which the financial ratios are usually computed for analysis are:
(a) Balance sheet which represents a statement of financial position of a firm at a given period of time, including asset-holding, liabilities and owner’s equity.
(b) Profit and loss statement (which is sometimes referred to as income statement) presents a measure of the net profit results of the firm’s operations over a specified interval. It is computed on an accrual rather than on a cash basis.
(c) Statement of charges in financial position (which is also known as sources and use of adds statement provides an accounting for the sources provided during a specified period and the uses which they are put).
Analysis of the above financial statements employing financial ratios requires low arithmetical skill. Ratios are of use principally to the higher levels of management, who are responsible for maximizing profits and planning for the future. One must understand the inner workings of the financial ratios and the significance of various financial relationship to interpret he data bearing in financial analysis as to provide information about an establishment and such information do not be limited to accounting data. Ratios based on past performance may be helpful in predicting future earnings capacity and financial projections of an establishment. We must beware of the different limitations of such data. Financial statement is merely a summary records of the past and we have go beyond the financial statement and look into the nature of the organization, its position within economy, its activities, its research expenditures and above all, the quality of its engagement before granting loan (MATHER 1979). Financial ratios are of four types and are used to analyse the financial position of a firm. They are:
1. Liquidity Ratios: These ratios indicate the firm’s capacity to meet short-run obligations. Liquidity ratios measure the firm’s ability to fulfill short-term commitments out of its liquid assets. These ratios particularly interest the firm’s short-term creditors liquid assets include accounts receivable and other debts owed to the firm which will generate cash when those debts are paid in the near future. Also included are cash and other assets as marketable securities and inventories either of which can be sold to generate funds for meeting maturing short-run obligations.
Two types of liquidity ratios are the current and quick ratio.
(a) Current Ratio: The simplest measure of the firm’s ability to raise funds to meet short-run obligations is the current ratio. It is the ratio of Current Assets to current liabilities. Current assets are viewed as relatively liquid which means they can generate cash in a relatively short time period. If current ratio is too low, the firm may have difficulty in meeting short-run commitments as they mature. If it is too high, the firm may have an excessive investment in current asset.
To reduce a high current ratio, the component(s) of current asset that is too large should be reduced and the funds invested in more productive long-term assets used to reduce debt or paid out as dividends to the owners of the firm.