JIMMA UNIVERSITY

SCHOOL OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING & FINANCE

A RESEARCH REPORT IN PARTIAL FULFILMENT OF THE REQUIRMENT

OF BA DEGRE IN ACCOUNTING & FINANCE

EVALUATION OF FINANCIAL PERFORMANCE COMMERCIAL BANK OF

ETHIOPIA

PREPARED BY: BIFTU FEYISSA

Advisor: - ATO MILLION GIZAWU

June 2012

Jimma, Ethiopia

ACKNOWLEDGMENT
First of all, I would like to thank the omnipotent God for his unreserved support throughout our
work. In particular, I would like to express our deepest and warmest gratitude and appreciation
to our advisor Ato Million Gizawu for his constructive comment, Suggestion and advise that
greatly enriched this paper beside to this. Beside to this, our deepest gratitude and thanks goes
to Mr. Sebil Ashenafi and kebeto Godana for their cooperation and Willingness to provide us
the necessary information for the Study.

ABSTRACT

This study is conducted to evaluate the financial performance of commercial bank. The
question which have been raise in this paper and addressed are the ability of the Bank to meet
its Obligation in the short runs‚ the extent to which commercial Bank use borrowed funds to
finance the company‚ the ability of the Bank to manage and utilize its total assets to generate
revenue‚ the capacity in generating adequate interest income to cover its expenses and earn a
profit.

The main objective of the study is to assess the financial performance of the company by using
different financial tools and provide the possible suggestion based on it.

This research is designed in descriptive method and mainly quantitative data are used. Data for
this research are gathered through both secondary and primary source. The secondary data
which covers most of the data are taken from the audited annual financial statement of
commercial bank and 0ther data to some extent are gathered through interviews with the bank
for further information verification.

The collected data have been realized by using different ratios and analysis. Finally‚ the
research arrived at some finding and recommendations.

Table of contents

Chapter one: Introductions Page

 1.1. Back ground of the study………………………………………………..……………..………………..1
1.2. Statement of the problem……………………………………………..………………………………….1
1.3. Objective of the study………………………………………………………..……………………………….2
1.4. Significance of the study………………………………………………………………………………………2
1.5. Methodology of the study……………………………………………………………………………………2
1.5.1 Research design……………………………………………………………….…………………………2.
1.5.2 Data collection methods…………………………………………………….……………………….3
1.6 Scope of limitation……………………………………………………………………..……………………….3
1.7 Organization of the study……………………………………………………………………………………3
Chapter Two: literature review
2.1. Introduction ………………………………………………………………………………………………………..4
2.2. Overview of financial statement…………………………………………………………………………..4
2.2.1 Demand for company financial statement………………………..……….……………..4
1.2.2 Types off financial statements……………………………………….…………………………5
2.3. Financial analysis definition………………………………………………………………………………….7
2.3.1 Purpose of financial statement analysis………………………………….…….………7
2.3.2 User of financial analysis…………………………………………………….………………….7
2.4. Ratio analysis……………………………………………………………………………….………………………..8
2.4.1 User of financial ratio analysis………………………………………………………………………8
2.4.2 Objective of ratio analysis……………………………………………………………………………..9
2.4.3 Classification of ratio analysis ……………………………………………………………………….9
2.4.3.1 Liquidity ratio……………………………………………………………………………………….9
2.4.3.2 Efficiency…………………………………..……………………………………………………….10
2.4.3.3 Leverage (turn-over) ratio…………………………………………………………………..11
2.4.3.4 Profitability ratio………………………………………………………………………………..12
2.5 Limitation of ratio analysis…………………….……………………………………………………………13
2.6 Overview of the bank…………………………….………………………………………………………… .13
2.6.1 Definition of the bank ……………….…………………………………………………………..13
2.6.2 Banks financial statement…………………………………………………………………….14
CHAPTER THREE: Data presentation and analysis
3.1 Overview of commercial Bank of Ethiopia…………………………………………………………15
3.1.1 Background…………………………………………………………………………………………………….15
3.1.2 Accounting policy of CBE………………………………………………………………………………..16
3.2 Data analysis…………………………………………………………………………………………………….19
3.2.1 Income analysis………………………………………………………………………………………………19
3.2.2 Expense analysis……………………………………………………………………………………………..20
3.2.3 Deposit analysis………………………………………………………………………………………………21
3.2.4 Ratio analysis………………………………………………………………………………………………….21
 3.2.4.1 Liquidity ratio………………………………………………………………………………….21
3.2.4.2 Activity ratio……………………………………………………………………………………22
3.2.4.3 Leverage ratio…………………………………………………………………………………23
3.2.4.4 Profitability ratio…………………………………………………………………………….24

Chapter four: SUMMARY OF FINDINGS RECOMMENDATION AND CONCLUSION

4.1 Findings……………………………………………………………………………………………………………………….26
4.2 recommendation…….……………………………………………………………………………………………………27
4.3 Conclusion……………….……………………………………………………………………………………………….….27

CHAPTER ONE
INTRODUCTION
1.1 Back ground of study
In this complicated Business world, any business entity should have a good financial
performance to sustain. Otherwise this entity is obliged to get out of the market. Therefore, the
management of the company should have adequate knowledge about the financial
performance of the company. If the company is performance well or have a good financial
performance the management should propose how to maintain this strength .on the other
hand ‚ if the company has weak financial performance, what expected from the management is
to make a good informed decision to improve the company. The management should propose
how to maintain the strength of the company.
Management of the firm would be interested in every aspect of the financial analysis and uses
ratio analysis to determine the firm`s financial strength or weakness and accordingly takes
action to improve the firm`s position. Financial analysis is the process of identifying the financial
strength and weakness of the firm by properly establishing relationship between the items of
the balance sheet and the profit and loss account. Financial statement analysis involves a
comparison of the firm`s performance with that of other firms in the same industry and an
evaluation of trends in the firm`s position over past time. The later one is the easiest way to
evaluate the performance of a firm. So, we considered it as a base of conducting research.
Generally, the assessment of the financial performance by using ratio analysis will greatly help
in making product decision to different operational strategic planning.

1.1 Statement of the problem

Accounting focuses on how financial statements are made. Whereas, our focus is on how they
are used by management to improve the firms performance. Financial statements both on the
firm`s position at a point in time and on its operation over some past period together given an
accounting picture of the firms operation and its financial position. Therefore, the analyzed
financial statements help the management to assess the current, past as well as future financial
strength and weakness of the firms and make appropriate decision. However, the researcher
wants to see the application of financial statement analysis to real world situation.

At the end of this paper, the following questions were addressed:-

=›Is commercial Bank`s financial performance has improved, deteriorated or remain constant
over the last 3 years. If there is a change, what is the reason for?
=›How is the liquidity of commercial bank
=›Is commercial bank generating adequate interest income to cover its expenses and earn a
profit?
=›How commercial bank managers utilities its total assets to generate revenue?
=›To what extant does commercial bank use borrowed funds to finance the company?

1.2Objectives of the study

The general objective of this research is to assess the financial performance of the company by
using different financial tools and to provide the possible suggestion based on it.
The specific objectives are the following:-
- To assess the ability of commercial bank to meet its obligation in the short run.
- To examine the extent to which commercial bank use borrowed funds to finance the
company.
- To assess whether or not the bank is generating adequate interest income to cover its
expenses and earn a profit.
- To examine how commercial bank manages utilize its total assets to generate revenue.

1.3 Significance of the study

Since financial statements of the firm contain important information. The data included in the
financial statement have a great economic consequence to its users. Because of the only
financial statement data are incomplete to understand the whole aspect of the business.
Financial statement analysis is important to make good financial decision.

In specific term the significance of this paper includes:-

- To make the bank managers to improve the use of financial statement.
- To help future research related to financial analysis by providing input.

- To relate financial analysis theory and concept to the practical world their by the
Researchers gain knowledge.

-Assist the management section by letting the know-how for how they are financially
performing and help them to take corrective action on their poor performance and enable
them to strength good performance and qualities.

1.5 Methodology of the study

1.5.1 Research Design

The research design includes descriptive, explanatory and causal method. This research is
design in descriptive method. Mainly quantitative data will be used for the research purpose.
All data are described in brief and the result is interpreted by examining the relationship
between various ratio data.

1.5.2 Data collection methods

To undertake this research both primary and secondary data are used. Secondary data
(documentary source) which covers most of the source are taken from the annual financial
statement of commercial bank and primary data to some extent are gathered through
interviews with the bank. To interpret the banks financial performance among the various ratio
analysis method trend analysis through graphical and tabular data analysis will applied.
Basically the reliability and validity to good research depends up on the quality of collected
data. Therefore to get relevant information verified financial statement will be used and all
necessary precaution will be taken. So as to ensure genuine information is obtained.

1.6 Scope and limitation

The research conducted in this paper was limited only to commercial bank financial analysis
which covers the last three years, Because of time, Money and other constraint. This research
was limited to time series analysis rather than cross sectional analysis.

1.7 Organization of the study

The study was organized in four chapters. The first chapter deals with the introduction including
background of the study, Statement of the problem, objectives of the study, significance of the
study, methodology of the study, research design, data collection method, scope and limitation
and organization of the study. The second chapter is about literature review and third chapter
deals with data analysis and interpretation. Finally, chapter four present Conclusion and
recommendation.

Chapter two
Literature review
2.1 Overview of the financial statements

The economic events and activities that affect a company and that can be translated in the accounting
numbers are reflected in the company’s financial statement. Some financial statement provides a
picture of the company at a moment in time. Other describe that took place over time. Both provide a
basis for evaluations what happened. For example what rate of growth can be expected next year?
There trends provide insights in to a market acceptance, Profit & liquidity. Consequently, a company
financial statements can be used for various purposes such as analytical tool, as a management report
card, as an early warning signal, as a basis for prediction and as a measure of accountability.(IM pandey:
Financial management. Page 65)

2.1.1 Demand for company`s financial statement

Company`s financial statements are demanded by several groups. These are:
Share holders and investors: - share holders and investors including investment advisory use
financial information to help decide on portfolio of security that meets for their preference for
risk. Return, dividend, yield & liquidity.

Managers and employees: although managers make operating and financial decision based on
information that is much more operating and financial decision based on information that is
match more detailed and timely than information found in the financial statement. They also
need and their fore demanded financial statement data.

Their demand arises from contracts (such as, executive compensation agreement) that are
linked to financial statement variables. Executive compensation contract frequently contain
annual bonus and long term pay components tied to financial statement result. On the other
hand because of the increasing popularity employees profit sharing and employees profit
sharing and employees stock ownership to monitor the heath of company`s sponsored pension
plans and to gauge the like hood that promised benefits will be provide up on retirement.

Lenders and suppliers:- financial statements play several roles, the relationship between the
company and lenders, who supply capital-commercial lender (banks, insurances company and
pension fund) use financial information to help decide the loan amount contractual provision
the borrower to maintain a minimum level of working capital interest coverage or other key
accounting variables that provide a safety-net to the lender. On the other hand supplier
demanded financial statement for many reason before extending credit suppliers assess the
financial strength of their customer in order to demand to determine whether they will be paid
good shipped.
Customers: - Repeated purchase and product guarantees create continuing relationship
between company and its customers. A buyer needs if its supplier has the financial strength to
deliver a high quality product on agreed schedule and if supplier will be able to provide
technical support after the sale. Thus financial statement information can help current potential
customer monitor supplier`s financial health and thus decide whether to purchase that
suppliers good and services.
Government and regulatory agency: demanded financial statement information for Various
purposes:-
=› A basis for establishing tax policy.
=› Government agency often a customer of business.
=› Used to regulate business especially public utilities. (BRIGHAM Haustone: financial
Management. Page 36)

2.1.2 Types of financial statements

Balance sheet: - A balance sheet (or statement of financial position) presents the financial
position of a business enterprise on a specific data. It also describe as a photograph of
company`s business at a moment in time. There are three elements of balance sheet these are:-
Asset: - are probable for economic benefit obtained or controlled by a particular entity as
a result f post transactions or events.
Liabilities: - are probable future sacrifices of economic benefits arising from present or
Provide services to other entities in the future as a result of past transaction or events.
=›Equity:- is the residual interest in the assets of an entity that remains after deducting its
liabilities in a business enterprise. The equity is the ownership interest.
There are three particularly important things to keep in mind when examining a balance sheet.
 Liquidity፡- refers to the speed and ease with an asset can be converted into cash./Ross/
 Debt Vs equity፡- to the extent that a firm borrows money. It usually gives claim to the
firm’s cash flow to creditors. Equity holders are 0nly entitled to the residual value the
portion left after creditors are paid. The value of these residual portions is the
shareholder equity holders are only entitled to the residual value the portion left after
creditor are paid . The value these residual portion is the shareholder equity in the firm
which is just the value of the firms asset less value of firms liability.
 Market value Vs book value : - the value shows on the balance sheet for the firm’s asset
are book value and generally are not what the asset is actually worth. Under generally
accepted accounting principle (GAAP) audited financial statement shows asset at
historical cost.
 Income Statement: - The income statement measure performance over some period of
time. usually quarter or year the income statement equation is
Income =Revenue- Expenses

If you think of the balance sheet as snapshoot ,that you can think of the income stamen as a
video recording covering the period between a before and an after picture.

The first thing reported on the income statement would usually be revenue and expense from
the firm’s principal operation. Subsequent part includes among other things financial expenses
such as interest paid are exported separately and the last item is net income. Net income often
expressed on per-share basis and called earning per- share.

 Statement of cash flows; - the balance sheet shows firms investment (asset) and
structure (liability and stock holder equity) at given point in time. By contrasting a
statement of cash flows shows the users. Why firm`s investment and financial structure
have changed between balance sheet data. Thus cash flows statement which provides
an explanation of why firm`s cash position what between successive balance sheet data.
Simultaneously explain the changes that have been taken place in the firm Non cash
asset. Liability and stock holder equity account over the same time period. The cash flow
statement summarizes the cash flows and out flow of company broken drowns in its
three principal activities.
A. Operating activities ፡- cash flow from operating activities resulting from the cash
effect of transaction and events that affect operating income both production and
delivery of goods and services.
B. investing activities :- cash flow from investing activities include making and collecting
loans investing and disposing of debt or equity securities of other companies and
purchasing and disposing of asset like equipment that are used by company in the
production of goods and services.
C. Financing activities ፡- cash flows financing activities include obtaining cash from new
insurance of stock or bonds paying amounts borrowing money and repaying amounts
borrowed. Statement of cash flows provides information not available from other
financial statement. It indicates how it is possible for a company to report net loss and
still making a large capital expenditure or pay dividend. It can also tell whether the
company issued or retired debt or common stock or both during the period.
Note of the financial statement: - information which can be significantly affect firms
financial condition is often contained in the notes to the financial statement. These
notes contain information and on the firms pension plan. On its Non-capitalized lease
agreement on its recent a question and divestitures on its accounting policies and so
forth. (Chandra: Fundamental of financial management, page 35)
2.3 Financial analysis definition
Financial reports covers both on firm position at point in time and its operation over
some post period. However, the real value of financial statement lies in the fact that can
be used to help prediction the firm’s future earnings and dividend. From an investor
point of view predicting future is what financial statements analysis all about and from a
management stand point financial statement analysis is useful both as a way to
anticipate future condition and more important as a starting point for planning action
that will influence the future course of event.
 2.3.1 Purpose of financial statement analysis
1. Financial statement analysis is information processing system designed to provide data
for decision maker. The information is basically derived from published financial
statement but in the process of analysis use is also made of non accounting data such as
stock price and aggregate economic indicator. Users of financial statement information
system are decision makers concerned with evaluating the economic situation of the
firm and predicting its future course. Given the various use and motive it is obvious that
no single information system will satisfy the requirement. (IM pandey: Financial
management. Page 25)
2.
2.3.2 Users of financial analysis
Financial analysis can be undertaken by management of the firm. Or by parties outside
the firm: - owners, creditors, investor and others. The nature of the analysis will differ
depending of the purpose of the analysis.
 Creditors: - are interested in firm`s ability to meet their clams over a very short
period.
 Suppliers of long term debt: - are concerned with the firm’s long term solvency
and survival. They analyze the firm`s profitability overtime, its ability to generate
cash to be able to pay interest and repay principal the relationship between
various sources of funds.
 Investors:-investors who have invested their money in the firm`s shares. Are
most concerned about the firm’s earnings.
3. Management of the firm:-would be interested in every aspect of the financial analyst. It
is their overall responsibility to see that the resources of the firm are used most
effectively and efficiently and that the firm`s financial condition is sound.( Kieso and
wexgand; Intermediate F/Accounting. 1998,page 25)

2.4 Ratio analysis

Ratio analysis has been the major tool used in the interpretation and evaluation of financial
statement for investment decision making. Generally such an analysis involves the breaker
down of examined financial report in to a component part (e.g. fixed and current asset) which
are then- evaluated in relation to other and exogenous standard. Ratios are indicator of firm`s
deficiencies such as poor liquidity or low profitability. Thus the negative function of ratio is
significant. (IM pandey: Financial management. Page 20)

2.4.1. Users of financial ratio analysis

To evaluate the financial condition and performance of a firm the financial analyst needs
certain yardsticks. The yardstick frequently used is a ratio or index relating two pieces of
financial data to each other. Analysis and interpretation of varies ratio should given
experienced skilled analyst a better understanding of a financial condition and performance of
the firm than they would obtain from analysis of financial data alone.

Trend analysis is the analysis of financial ratio, which involves two types of comparisons. First
the analyst can compare & present ratio with post and expected future ratio for the some
company. The current ratio (the ratio of current assets to current liabilities) for the year and
could be compared with the current ratio for the preceding year. When financial ratios are
arrayed on a spread sheet over period of year the analyst can study the composition of change
and determine whether there has been an improvement or deterioration in the financial
condition and performance over time.

Financial ratio also can be computed for protected statements and compared present and post
ratios. In the comparison overtime, it is best to compare not only financial ratios but also raw
figures. The second method of comparison involves comparing the ratios of one firm’s with
those of similar firms or with industry averages at the same point in time Such as a comparison
gives insight in to the financial performance of the firm.
In order to get adequate information about a company`s performance and future conditions we
can use a number of methods. Some of this are:-
1. Ratio analysis: - it is a powerful tool of financial analysis. A ratio is defined as
indicated quotient of two mathematical expressions.
2. Index analysis: - it supports the traditional analysis. The items in the financial
statement are expressed as an index relative to the base year.
3. Common size analysis: - it is another method of financial analysis. It expresses
the status of each item in the balance sheet as percentage of total asset or net
and each items of income statement as percentages of total sales (net).
4. Trend analysis:-in financial analysis the direction of change over period of year is
given importance.
4. To this particular paper we will be using the most important financial performance
analysis method called ratio analysis. This will be defined in detail as follow.( Eugene F.
Bringham; fundamental of F/Management. 10t h ed.page 40)

2.4.2 Objective of ratio analysis

The major objectives of ratio analysis is considered to be facilitation of statement interpretation
this is basically achieved by reducing the large number of financial statement items to relatively
small set of ratio such as relate the absolute value of financial item to common basis (e.g. total
asset) allowing a meaningful comparison of financial data both overtime and across firms for a
given time period however financial ratio are not intended to provide definite answer their real
value is derived from the question they provoke. Ratios are therefore symptoms of the firms
economic condition intended to guide the analysis in his financial investigation. (Ross Stephan A:
Fundamental of corporate finance, page 41)

2.4.3 Classification of ratio analysis

There are four categories of ratio analysis. Each ratio measure a particular aspect of the firm’s
position and performance.
1. Liquidity ratio
2. Activity ratio
3. Leverage ratio
4. Profitability ratio (Ross Stephan A: Fundamental of corporate finance.
Page 48)

2.4.3.1 Liquidity ratio

Liquidity refers to the ability of a firm to meet its obligations in the short run, usually one year.
Liquidity ratios are generally based on the relationship between current assets (the sources for
meeting short-term obligations) and current liabilities.

The important liquidity ratios are:-

o Current ratio and
o Quick ratio
Current ratio: - the current ratio measures the ability of a firm to meet its current liabilities-
current assets converted in to cash in the operating cycle of the firm and provide the funds
needed to pay current liabilities. Apparently, the higher the current ratio, the greater the short
term solvency.
However, interesting the current ratio the composition of current assets most not be over
looked. A firm with a high proportion of current assets in the form of cash and account
receivable is more liquid than one with a high proportion of current assets in the form of
inventories even through both the firms have the some current ratio.
Current ratio¿ current asset
Current liabilities

Quick ratio: - it establishes relationship between liquid assets and current liabilities. It is the
same as current ratio except that it excludes inventories presumably the least liquid portion of
current assets from the numerator.
The ratio concentrates on cash marketable securities in relation to current obligations and thus
portion of current assets from the numerator.
The ratio concentrates on cash marketable securities in relation to current obligations and thus
provides a more penetrating measure of liquidity than does the current ratio. The formula to
calculate the ratio is
Quick ratio¿ current- inventory
Current liability
Quick ratio is also reflecting the firm`s ability to pay its short term obligations and the higher
the quick ratio the more liquid the firm`s position.

2.4.3.2 Efficiency (turn over) ratio:-

The objective of this ratio is to indicate various aspects of operational efficiency, attention is
focused her, on a specific asset rather than on the overall efficiency of asset utilization
measured by the profitability ratio.

Fixed asset turnover ratio: - this ratio indicates the extent to which firm is using existing
property, plant and equipment to generate revenue. Higher fixed assets turns over ratio are
supposed to effect better than average fixed asset management and lower ratio to represent
poorer management.

Fixed asset turn over¿ sales

Fixed asset

Total asset turnover ratio: - It measure the turn over all of all the firm`s asset it indicate how
effectively firm use its total resource to generate sales and is a summary measure influenced by
each of asset management ratio. High total assets turns over ratios are suppose to indicate
successful asset management and low ratio to indicate unsuccessful management.
Total asset turn over= sales____
Total assets
2.4.3.3 Leverage (Long- Turn solvency ratio):-
The purpose of long-term solvency ratio is to indicate the firm’s ability to meet both the
principal and interest payment on the long-term obligation as opposed to short term liquidity
ratio these measures stress the long- term financial and operating structure of the firms.

Debt-equity ratio:-shows the relative contributions creditors and owners.

Debt- equity ratio = Debt

Equity
The numerator of this ratio consists of all liabilities. Short term as well as long- term and the
denominator consist of net worth plus preference capital. In general the lower the debt-equity
ratio, the higher the degree of protection enjoyed by the creditors.

Debt ratio: - measures the extent to which borrowed funds support the firm`s assets.

Debt ratio = Debt

Asset

Time interest earned: - times interest earned is supposed to measure how easily the firms can
meet its interest obligations. Many times the interest payments are covered by funds that are
normally available to pay interest expense. The lower ratio of times interest expense. The lower
ratio of times interest the more a firm uses debt than its typical competitor.
Time interest earned = Net operating income
Interest expense
EBITDA Coverage ratio፡-
The time interest earned ratio is useful for assessing a company`s ability to meet interest
charges on its debt. But this ratio has two short comings:-

1. Interest is not the only fixed financial charge. Compares must also reduce debt on
schedule, and many firms lease assets and thus must make lease payment.
2. EBIT does not represent all the cash flow available to service debt, especially if a firm has
high depreciation and/or amortization charges. To account for these deficiencies,
bankers and others have developed the EBITDA coverage ratio, defined as follow;
EBITDA coverage ratio = EBITDA + Lease payments
Interest + principal payments + lease payments

The EBITD coverage ratio is most useful for relatively short term lenders such as banks and
other relatively short term bond holder’s focus on the time interest earned ratio (BRIGHAM and
HOUSTON. Page 85)

2.4.3.4 Profitability ratio

A company should earn profit to survive and grow over a long period of time. Profit are
essential, but it would be wrong to assume that every action initiated by management of a
company should arrived at maximizing profit, irrespective of social consequence. It is
unfortunate that the world profit is looked up on as a term of abuse since some firms always
want to maximize profit at the cost off employees, customer and society.
Except for such infrequent case, it is fact that sufficient profits must be earned to sustain the
operation of the business to be able to obtain funds from investors from expansion and growth
and to contribute towards the social overheads for the welfare of the society. Profit is the
difference between revenue and expense over period of time and is ultimately the output of a
company. It will have no future if it falls to make sufficient profits. A manager should
continuously evaluate the efficiency of its company in terms of profit. Profitability ratios are
calculated to measure the operating efficiency of the company.

Basic Earning Power (BEO) Ratio: This ratio indicates the ability of the firm`s assets to generate
operating income: calculated by dividing earnings before interest and tax (EBIT) by total assets.

BEP ratio= EBIT

Total assets

This ratio shows the row earning power of the firm`s assets. The influence of taxes and
leverages: and it’s useful for comparing firms with different tax situations and different of
financial leverage.

Return on Asset Ratio:- Is a measure the return on total asset after interest and tax

ROA = Net income available to common stock holder

Total asset

RETURN ON EQUITY RATIO: -Is the most important accounting ratio which measures the return on
common equity.

ROE = Net income available to common stock holder

Common Equity

2.5 limitation of ratio analysis

The ratio analysis is widely used technique to evaluate the financial position and performance
of a business.

But there are certain problems in using ratios. The analysis should be aware of these problems.
The following are some of the limitation of the ratio analysis.

1. Many large, firms operate different division indifferent industries and for such
companies it is difficult to develop a meaningful set of industry averages. Therefore,
 ratio analysis is more useful for small, narrowly focused firms than for large,
multidivisional ones.
2. Most firms went to better than average, so merely attaining average performance is not
necessarily good.
3. Inflation may have badly distorted firm`s balance sheet recorded values are often
substantially different from `true` values are often substantially different from `true`
values.
4. Seasonal factors can also distort analysis.
5. Firm can employ window dressing techniques to their financial statements look
stranger.
6. Different accounting practices can distort comparisons.
7. It is difficult to generalize about whether a particular ratio is good or bad. For example,
high current ratio may indicate a strong liquidity position which is good or bad. For
example, high current ratio may indicate a strong liquidity position which is good or
excessive cash which is bad.
8. A firm may have some ration that look good and other that look bad making if difficult
to tell whether the company is on balance strong of we

2.6 Overview of the bank

2.6.1 Definition of the bank

Etymologically, however, the word `bank` is derived fro the Greek word banque or the
Italian word banco both meaning a bench referring to a bench at which money-lenders
and money changers used to display their coins and transact business in the market
place. (D.M Methane)
Bank can be defined as any organization in any or all of the various function of banking
that means collecting, transferring, paying, lending, investing, dealing, exchanging and
servicing money and claims to money both domestically and internationally. In its more
specific sense, however the term bank refers to an institution which accepts deposits
from the public since, however the term bank refers to an institution which accepts
deposits from the public and in turn advances loans by creating credit. (M.L.Jhingan

2.6.2 Banks financial statement

Just as any other business enterprise, Banks also are accountable and have their account
presented to the public and their clientele, in the form of stock as well as flow of document,
Balance sheet and statement of cash flow are presented every year to the share holders of the
bank who have contributed capital in organizing the company and other interested group.
 CHAPTER THREE
3. DATA PRESENTATION AND ANALYSIS

3.1 OVERVIEW OF COMMERCIAL BANK OF ETHIOPIA

3.1.1 Back ground

The first commercial bank of Ethiopia was established bank of Abyssinia in 1905, under the
partnerships of Ethiopia government and the national bank of Egypt. The bank continued to
operate until 1931. And later on the government of Ethiopia purchased and renamed `the bank
of Ethiopia` this also operates until the Italian invasion in 1936.

In 1963 commercial bank of Ethiopia was legally established. As a share company, to take over
the commercial banking activities of the state bank of Ethiopia and to carry on all types of
banking business and operations competing with other banks. The bank was established in
accordance to the licensing and supervision of banking business proclamation No 84/1994 of
Ethiopia to undertake commercial banking of activities.

1981-1993: in this period. CBE was in monopoly era dominating the banking business all over
the country.

1994-1998: this period was characterized by the country`s shift from a command economy to
market oriented economy: due to a policy redirection.

1998-2000: as the business environment, Continued to became increasingly competitive due to

the establishment of private banks. CBE commissioned a comprehensive audit program (CAP)
with the renowned expatriate. Consulting firm: Ernst & young.

2000-onwards: the bank has commissioned a financial audit with an audit with an audit firm
KPMG in East Africa LTD. As prerequisite to the management consultancy program, the bank
actually concluded a management consultancy contract with the bank of Scotland (Ireland) on
April 16, 2003. Currently, the commercial Bank of Ethiopia is the leading bank in the country.
The bank`s leading position is expressed by the virtue of its:

- Market share
- Volume of business
- Wide customer base
- Wide branch network
- Strong relationship with internationally acclaimed banks.
- Asset size &
- Capital base

Now a day through the head office in Addis Ababa and about 303 branches exist in the country.

CBE`s vision is to become an icon of excellence and a world class of commercial bank.

CBE`s mission is to maximize shareholders value through enhanced financial intermediation and
unparalleled customer satisfaction. The bank deploy highly motivated, skilled and disciplined
employees capable of providing banking products and services that means international best
practices and standards.
The bank strongly believes that reliability and public confidences are the basis of our success.

CBE`s values are standing for quality and a learning organization. It is committed to unparalleled
customer satisfaction and the employees are the banks valuable assets. The bank also
committed to maximize shareholders value and upholding transparency, Accountability and
professionalism. The bank has an equal opportunity employer and corporate citizen.

3.1.2 Accounting policy of CBE

The following are the major accounting policies adopted by the bank. These policies are
consistent with those applied in the preceding year.

A. Basis of preparation

I. These financial statements have been prepared in compliance with international financial
reporting standards. They are prepared under the historical cost convention.

II. All amounts in the financial statements are expressed in term of Birr.

B. Consolidation principles

I. Subsidiary:-
Subsidiaries are enterprise controlled by the bank. Control exists when the bank has the power,
directly or indirectly, to govern the financial and operating policies of an enterprise so as to
obtain economic benefits and operating policies of an enterprise so as to obtain economic
benefits from its activities. The financial statements of subsidiaries are included in the
consolidated financial statements of subsidiaries are included in the consolidated financial
statements from date control commences until the date control ceases.
The consolidated financial statements incorporate financial statements of the bank and its
subsidiary for the year ended 30june 2009.
The subsidiary is shown in note 10.
All intercompany balances and transactions are eliminated on consolidation.

II. Associates
Associates are enterprises in which the bank has significant influence, and are neither
subsidiaries nor joint venture. The bank`s investment in associates is accounted for in the
Consolidated financial statements using the equity method. The bank`s associates are shown in
note 11.

C. Valuation of assets and liabilities

1. Assets and liabilities denominated in foreign currencies are translated in to birr at the
exchange rates ruling at the balance sheet date.
 2. All major financial assets are measured at fair value.
3. Impairment losses on loans and advances.
Loans and advances are shown at the gross amount adjusted for any provision for
impairment losses. A provision for loan impairment is established if there is objective
evidence that bank will not be able to collect all amounts due according to the original
contractual terms of the loan. The amount of the provision is the difference b/n the
carrying amount and the estimated recoverable amount.
In addition, a general provision is made based on management’s assessment of the
inherent risk in the loan and advances portfolio. When a loan is deemed uncollectable, it
is written off against the related provision for impairment. Subsequent recoveries are
created to the provision for loan losses in the income statement.

4. Property and equipment

Buildings, fixtures, fittings and office equipment, motor vehicles, computers, accessories and
software are stated at cost less accumulated depreciation and impairment losses…

Depreciation is charged on a straight-line basis over the estimated useful lives of the assets.
Buildings…………………………………………………………………….5%
Fixtures, fittings and office equipment……………………….10%
Motor vehicles…………………………………………………..……..20%
Computers and accessories……………………………………….10%
Computer software…………………………………………………..20%
Gains and losses on disposal of property and equipment are determined by comparing
the proceeds on disposal and the carrying amount of the respective item and are taken
in to account in determining operating profit.
5. Stocks: - Stocks are stated at cost less any provision for impairment.

D. Recognition of financial assets and financial liabilities

The bank recognizes a financial liability on its balance sheet when, and only when, the control
over the contractual rights is lost. A financial liability is derecognized when, and only when, it is
extinguished.

E. Income recognition
Income is recognized in the period in which it is earned. When a lending account becomes non-
performing, Interest is suspended and exclude from income until it is received. However, it is
computed and shown in the memorandum account.
 F. deferred income tax
Deferred tax is provided, using the balance sheet liability method for all temporary differences
arising b/n the tax bases of assets and liabilities and their carrying values for financial reporting
purposes. Currently enacted tax rates are used to determine deferred income tax.

G. Employee benefits
Bank employees are eligible for retirement benefits defined contribution plan. Contributions to
the defined contribution plan are charged to the income statement as incurred.

H. trust funds
The bank and its subsidiary act as trustees and in other fiduciary capacities that result I the
holding or placing of assets on behalf of individuals, trusts, retirement benefit plans and other
institutions.
Assets held in trust are not included in the balance sheet of the bank and its subsidiary.

Abbreviations
CBE stands for commercial bank of Ethiopia while CN stands for commercial nominee`s private
limited company.

3.2 Data analysis

As explained in chapter one the general objective of this papers it to evaluate the financial
performance of commercial bank of Ethiopia. This topic discloses data analysis for the past
three consecutive years to evaluate the performance, mean year 2007, 2008 and 2009 G.C

3.2.1 Income analysis

Absolute percentage
Item 2007 2008 2009 2007/08 2008/9 20070 2008/0
8 9
Interest 1,036,505,089 1,541,154,077 2,357,879,167 504648988 816,725,09 48.68 52.99
income 0
from loan
and
advance
0ther 1,225.281,456 1,430,306,137 1,301,764,505 205,024,681 71,458,371 16.73 4.99
income
Total 2,261,786,545 2,971,460,214 3,859,643,675 709,673,869 888,183,46 31.38 29.89
1

As indicated the above table, the aggregate income of the bank increase continuously. In 2007,
2008 and 2009 the bank earned an aggregate income of 2,261,786,545: 2,971,460,214 and
3,859,643,675 respectively.

In 2008 and 2009 the registering an increase of 31.38 and 29.89 respectively when compared
with the result achieved to that of the preceding years.

Income from interest on loans and advances for 2008 and 2009 showed a significance growth
when compared with that of the preceding year. This account also counted for more than half
of the preceding year. This account also counted for more than half of the total for each year.

3.2.2 Expense analysis

Change in (000.000)

Absolute percentage
Item 2007 2008 2009 2007/08 2008/9 20070 2008/0
8 9
Interest expense 350,965,7 533,886,482 614,089,057 182,920,729 80,202,59 52 15
33 5
Impairment losses
on loans and 2,503,097 11,792,111 7,882,683 3,285,014 3,909,428 38.7 33.15
advance sundry
debtors

Acquired
property

Other 729,162,418 556,058,277 517, 846,870 173,104,141 38,011,407 23.74 6.9

expense
total 1,088,831,248 1,101,736,850 1,139,618,81 359,313,884 122,523,430 33 11.12
0

As shown in the above the aggregate expense in 2008 and 2009 financial year reached birr
1,101.74 million and birr 1, 139, 6 million respectively.

They exceeded those of the preceding financial year figure by 33% and 11.12% respectively.
During 2009, interest expense has increased by birr 80 million or 15% over the preceding year
due, to substantial growth of saving deposits during the financial year.

Generally the aggregate expense for the last three years has been increased due to an
increment of varies expense such as annual saving deposit and other expenses.

3.2.3 Deposit analysis

Absolute percentage
Type of
deposit 2007 2008 2009 2007/08 2007/09 20070 2008/
s 8 09

Deman 32, 810,997,657

d 36,527,796,190 42,317,842,69 3,716,798,54 5,789,846,50 11.33 15.85
deposit 0 0 0
Saving
deposit 189,639,718 478,830,674 1,171,767,848 289,150,956 692,937,174 152.49 144.7
s
Total 33,ooo,837,037 37,006,626.86 43,489,410.54 4,005,989.5 6,482,783,67 12.4 17.52
4

As shown in the above table the total deposit mobilized by the bank has been increased
continuously. In 2008 and 2009 financial year the total deposit of the bank was 57,006.63
million and 43,489,410.54 and registering an increase of 12.47 and 17.52% respectively when
compared to with the preceding years.

The overall increase is total deposits was result of the opening of additional branches, the
improvements made customer service and ensuring growing confidence of the public.

3.2.4 Ratio analysis

As explained in chapter two ratio analyses is one of the major tools used in the interpretation
and evaluation of financial statement data. In this topic the various types the values types of
ratio analysis is used to interpreter and evaluate the commercial banks financial statement and
evaluate the financial performance in the last years.

1. liquidity ratio

Liquidity ratio measure the ability of the firm to meet its current obligation. The important
liquidity ratios are current and quick ratio. Since the banks have no inventory item within their
financial statement. We can use either of the ratios to evaluate the performance of the bank.
 Current ratio
This ratio measures the ability of commercial bank to meet it current obligations.

- Current liability is paid by using its current asset

Current ratio = Current asset

Current liability
2007= 40,883,614,330 =1.044
39,162,165,584
2008= 47,484,588,540 =1.037
45,774,568,035
2009= 55,713,623,060 = 1.025
54,356,916,741
In the post three years the banks current ratio was greater than 1. It indicate that the bank have
more than 1 birr for each birr in current liabilities covered at least equal time over. As a result
the banks have the ability to cover the claims of short term creditors.

In the above current ratio indicates in 2007 commercial bank of Ethiopia has birr 1.044 in
current asset available for every one birr in current liability in 2008 and 2009 the ratio
continuously declined to 1.037 and 1.025 respectively. Since the banks current ratio are still
moderate the current assets of the bank are sufficient to pay its current liability.

2. Activity ratio

Activity ratios are employed to evaluate the efficiency with which the firm manages and utilized
its assets for this analysis purpose we use fixed asset turnover ratio.

 Fixed asset turnover ratio (FACTOR)

This ratio indicates the extent to which firm is using existing property, plant and equipment to
generate revenue.
FATOR = Revenue
Fixed asset

2007 = 2,261,786,545 = 9.39

240,700,945
2008 = 2,971,460,214 = 9.94
312,052,222
2009= 3,859,644,037 = 9.87 -22-
391,011,620
In the above shown the bank’s ability in using its existing property, plant and equipment to
generate revenue in the last three years were presented. In 2007 the banks uses its fixed asset
9.39 times generating the annual revenue of 2,261,786,545 and 9.87 for revenue 2,971,460,214
in 2008 and 3,859,644,037 in 2009 respectively.
 Total asset turnover ratio(TATOR)

At it has been indicated in the literature review this ratio indicates how effectively firm use its
total resource to generate revenue.

TATOR = Revenue

Total asset

2007 = 2,261,786,545 = 0.052

43,388,923,983
2008 = 2,971,460,214 = 0.059
 50,343,473,671

2009 = 3,859,644,037 = 0.065

59,411,719,247
In 2007 the bank total resource turns in average 0.052 times to generate revenue of
2,261,786,545 in year while in 2008 and 2009 the total asset turns 0.059 and 0.065 times
annually to generate revenue of 2,971,460,214 and 3,859,644,037 respectively. The total asset
turnover ratio of the bank has been increased from 2007 to 2009. This is a clear indication of
the bank`s efficiency in using its total asset in relative to revenue.
3. Leverage ratio
As discussed in the literature review the purpose of leverage ratio is indicate the firm`s ability
to meet both the principal and interest payment on the long term obligation.
For this analysis purpose we use debt ratio of financial leverage and time interest earned ratio
of coverage ratio.
 Debt management ratio
This ratio measures the extent to which borrowed found support the firm assets.
Debt ratio = Total debt
Total asset
2007 = 39,162,165,584 = 0.90
43,388,923,983
2008 = 45,774,568,035 = 0.901
50,343,473,671
2009 = 54,356,916,741 = 0.91
59,411,719,247
In 2007 the total capital financed by the creditors was 90%.1 and 91% in 2008 and 2009
respectively.
The debt ratios of the bank have been increased from 2007 to 2009. But it is a small difference.
This implies that firm`s assets are provided by creditors relative to owners.

As a result tie firm may face some difficulty in raising additional debt and further creditors may
require a higher rate of return (interest rate) for taking higher risk.

 Time interest earned ratio

Time interest earned ratio is intended to measures how easily the firm can meet its interest
obligation.

TIE ratio = EBT

Interest
2007 = 1,524,121,030 = 4.3
 350,965,733

2008 = 2,403,609,826 = 4.5

533, 886, 462
2009 = 3,334,114,484 = 5.4
614,089,057

The above ratio indicates the ability of the bank to meet its annual interest charge. in each year
the bank’s ability to meet its annual interest charge increased by relatively high margin of
safety. In 2007, 2008 and 2009 the banks margin safety was 4.3, 4.5 and 5.4 respectively.

Generally as the above ratio shows the bank can raise additional burrowing in the future
without any difficulty since it assures its future strong position.

4. profitability ratio
These ratios are used to measure the management effectiveness. In describes the firms past
profitability. Even if there is little evidence that past profitability will indicate the future
prospect, this ratio is very important in evaluating performance. For this analysis purpose we
use basic earning power ratio and turn on asset.
 Basic earning power ratio
This ratio indicates the ability of commercial bank of Ethiopia asset to generate income before
fax and leverage.
BEP ratio= EBIT
Total asset
2007 = 1,524,121,035 = 0.035
43,388,923,983
2008 = 2403,609,826 = 0.048
50,343,473,671
2009 = 3,334,114,484 = 0.056
59, 411,719,247
The banks BEP ratios were 3.5% 4.8% and 5.6% for the last three consecutive years respectively.
They are reflection of the bank’s total asset power in generating annual revenue in percentage.
The ratio is the above indicate the BEP ratios of CBE have been increased from 2007 to 2009.
The growth from 2007 to 2008 and 2008 to 2009 was increased relatively in high percentage.

 Return on asset (ROA)

This ratio measures the return on total asset after interest and tax
ROA = Net income
Total asset
2007 =866,565,301 = 0.020 -25-
 43,388,923,983
2008 = 1,362,564,354 = 0.027
50,343,473,671
2009 = 1,924,235,824 = 0.032
59,411,719,247
As shown from the above in each consecutive year the ratio is ranged from 2% to 3.2%. in 2007
it was 2% and 2.7% and 3.2% in 2008 and 2008 and 2009 respectively.
These ROA is increased from 2007 to 2009. This reflects the bank is utilizing its total assets
effectively in the process of generating revenue.

CHAPTER FOUR
SUMMARY OF FINDINGS, RECOMMENDATIONS AND CONCLUSION
4.1 Finding
as explained in chapter one the general objective of this study is to assess whether the financial
performance of commercial bank of Ethiopia improved deteriorated or remain constant over
the last three years by using different financial tool and provide possible suggestion based on it.
Based on the data analysis of chapter three and using the annual report of commercial bank of
Ethiopia, researcher reached the following findings.
 When we see the aggregate income, expense and deposit mobilized by the bank for the
three consecutive years, it showed continues. This is a reflection of the bank`s strong
performance in its actuates.
 Even through the bank`s ability to meet current liability by using its current asset is
decreasing continuously in the past three years, the ratio is still moderate and may not
face difficult in paying its short term obligation.
 The fixed asset turnover ratio of commercial bank of Ethiopia throughout 2007 to 2008
was improved. But from 2008 to 2009 was decreased. From 2007 to 2008 implies that
the bank has good ability in using its existing property, plant and equipment to generate
revenue, But 2008 to 2009 implies the bank has weakness ability in using it.
 The total asset turnover ratios of commercial bank of Ethiopia from 2007 to 2009 have
been increased .this indicates that the bank is effectively using its total resource to
generate revenue.
 According to the analysis of debt management ratio of the for the year 2007, 2008 and
2009 we can identify that all the three years register higher debt ratio. The result
indicates the banks asses are provided by the creditors relatively to owners. This shows
the existence of weak capital structure in the bank.
 Regarding the ability of bank to meet its annual interest charge. Commercial bank of
Ethiopia time interest earned ratio shows high margin of safety throughout the 3 years.
as the ratio shows the bank can raise additional borrowing in the future without any
difficult since the bank can easily meet its interest obligation.
 Commercial bank of Ethiopia basic earning power ratios have been increased from 2007
to 2009. This indicates that the banks total assets are in good position to generate
income before tax and.
 The return on asset of commercial bank of Ethiopia indicates the bank is utilizing its total
assets effectively in the process of generating revenue.

4.2 Recommendation
Based on the data analysis made on the auditing financial statement of commercial bank of
Ethiopia and the conclusion reached we recommended the following points in general.
 If the situations regarding the current ratio of commercial bank of Ethiopia continuous
to decline like this, the company may face difficulty in paying its short term obligation in
the near future. Therefore, the bank should try to improve its ratio by long term
 barrowing the increase current asset and liquidating current liabilities using long term
financing. This action could enable the bank to provide the greater margin of safety for
creditors.
 As we have seen in the debt management ratio of commercial bank of Ethiopia. It shows
higher debt ratio throughout the three years.

Higher ratio shows more of bank asset are provide by creditors relative to owners. They
may face some difficulty in raising additional debt and further creditors may require a
higher rate of return fore of return for taking higher risk.

A higher level of debt introduces in flexibility in the bank`s operations due to the increasing
interference and pressure from creditors. Furthermore creditors prefer moderate or law
debt ratio because, low debt ratio provides creditor more protection in case of a bank
experiences financial problem. Therefore the bank should strive improve its capital financed
by creditor below 50%

 The bank management should take precaution in utilization of its total asset to generate
revenue because total asset turnover ratio have a direct effect on the basic earning
power ratio and at the same time the BEP ratio have a direct impact on ROM ratio (that
means total asset turnover ratio has a direct impact on profitability of the company)

1.1 Conclusion

Based on the data analysis to chapter three the researchers conclude that the CBE total income
expense and deposit were increased and the financial statement analysis through ratio analysis
shows that the bank improved its performance over the last three years.

Bibliography

1. Eugene F. Bringham; fundamental of F/Management. 10t h ed. 1996.

2. BRIGHAM Haustone: financial management. 10t h ed

3. IM pandey: Financial management. 8t h ed.

 4. Chandra: Fundamental of financial management. 3rd ed

5. Annual report of CBE 2007/08

6. Annual report of CBE 2008/09

7. Dolald R.cooper: Business research method 9t h edition

8. Ross Stephan A: Fundamental of corporate finance. 6t h edition, 2003

9. Kieso and wexgand; Intermediate F/Accounting. 1998

10. D.M Mithani; money, banking, International trade and public Financial, 11t h edition

1998

11. M.L Jhingan money, Banking, international trade and public Finance 6t hedition 1997

INTERVIEW question.

1. When does commercial bank of Ethiopia established in Ethiopia

2. How many branches the commercial banks of Ethiopia are there in Ethiopia

3. What are the main objectives and general objectives of the bank?
 4. What is the vision of CBE?

5. What is the mission of CBE?

6. What kind of accounting policy did the bank uses in preparation of financial statements?

7. What are the main sources of income and also spending unit of the bank?

8. What is the balance sheet of the last three years?

9. What are the income statements of the bank for the last three years?

Commercial Bank of Ethiopia

Bank balance sheet

At 30 June 2008

Assets notes 2008,birr 2007,Birr

Cash and balance with national bank of Ethiopia 2 9,860,907,382 9,869,645,784

Investments in government securities 3 6,518,502,714 13,013,380,234
Coupon bonds with development bank of Ethiopia and
Regional states 4 4,756,806,075 1, 874,831,052
Term bonds 5 8,600,000,000 6,100,000,000
Placements with other banks 6 1,465,221,078 1,642,643,144
Loans and advances to banks 7 180,414,140 230,703,646
Loans and advances to customers 8(a) 16,094,699,102 8,144,372,423
Investment in subsidiary 9 4,220,000 4,220,000
Investments in associates 1b(ii),10(b) 1,050,000 1,050,000
Other investments 11 2,768,051 2,768,051
Other assets 12 2,559,882,606 2,264,608,674
Property and equipment 1c(iv),13 299,002,523 240,700,975
50,343,473,671 43,388,923,983
Liabilities
Deposits due to other banks 14 478,830,674 189,639,718
Customer`s deposits 15 36,527,796,190 32,810,997,657
Taxation 16 502,643,363 302,029,172
State dividend payable 17 1,020,893,667 648,418,071
Other liabilities 18 7,244,404,141 5,211,080,966
45,774,568,035 39,162,165,584
Net Assets 4,568,905,636 4,226,758,399
Capital and reserves
Capital 19 4,000,000,000 4,000,000,000
Legal reserve 20 556,266,626 216,139,356
Retained earnings 4,241,827 4,241,827
4,560,508,753 4,220,381,183
Deferred tax liability 1F,21 8,396,883 6,377,216
4,568,905,636 4,226,758,399

The notes on pages 24 to 47 from an integral part of these financial statements.

Commercial Bank of Ethiopia