Introduction to DEA: application of

financial ratios and DEA in the

power sector of Bangladesh

Course: Intermediate Accounting

Submitted to:
Azharul Islam
Lecturer
Faculty of Business Studies

Submitted by:
Ahnaf Sadat Zakaria (B18231061)
Shamaila Nawaar Noor (B18231057)
Anika Haq (B18231011)
Ayesha Atiq (B18231065)
Md. Khaled Saifullah (B18231045)

Thursday Bangladesh University of Professionals

November 7, 2019 Mirpur Cantonment, Dhaka-1216
ACKNOWLEDGEMENT

It is high time for us to express our deepest gratitude and humble submission to the Almighty
Allah without Whose support; we would not able to complete a huge task of preparing this term
paper within the scheduled time. Term paper is an essential part of BBA program as one can
gather knowledge and, in this case, practical experience by preparing the paper. At first, we
would like to give full gratitude to our course teacher Azharul Islam, Lecturer, Intermediate
Accounting, Faculty of Business Studies (FBS), Bangladesh University of Professionals (BUP),
who instructed us in the right way and gave us proper guidelines for preparing this term paper.
We sincerely believe that the road to improvement is never ending. Hence, we shall look
forward to and gratefully acknowledge all suggestions received.
LETTER OF TRANSMITTAL
November 7th, 2019

Azharul Islam

Lecturer

Department of Business Administration -General

Bangladesh University of Professionals

Subject: For the acceptance of term paper

Respected Sir,

With great pleasure we are submitting our term paper on the topic, “Introduction to DEA:
application of financial ratios and DEA in the power sector of Bangladesh.” While preparing this
term paper, we have followed your instructions and guidelines with attention and diligence.

This report has been completed primarily with the combined effort of all group members and in
addition to your proper guidance.

We express our special gratitude to you for dedicating your valuable time, expert guidance and
support. We have tried our best to complete the report appropriately as much as possible. We
shall be pleased to answer any sort of query you may have regarding this report. We hope with
great anticipation that you would like and accept our report, looking forward to your co-
operation.

Sincerely Yours,

Ahnaf Sadat Zakaria (B18231061)

Shamaila Nawaar Noor (B18231057)

Anika Haq (B18231011)

Ayesha Atiq (B18231065)

Md. Khaled Saifullah (B18231045)

Contents
ACKNOWLEDGEMENT.................................................................................................................................2
LETTER OF TRANSMITTAL............................................................................................................................3
Abstract.......................................................................................................................................................5
1.Introduction..............................................................................................................................................6
2.Literature Review.....................................................................................................................................8
3. Data acquisition and methodology..........................................................................................................9
3.1. Data acquisition................................................................................................................................9
3.2 Methodology...................................................................................................................................10
DEA....................................................................................................................................................10
Financial Ratio...................................................................................................................................11
4.Findings..................................................................................................................................................12
The financial ratios are:.........................................................................................................................12
The DEA analysis:...................................................................................................................................13
Concnlusion:..............................................................................................................................................14
Reference..................................................................................................................................................15
Abstract

The goal of this study is to measure the operating efficiency of the power industry and to
highlight the status of operation performance so that managers can find a strategy to improve
their performance. In this paper, we used data envelopment analysis (DEA) technique in
conjunction with financial indicators to evaluate the efficiency of four computer’s peripheral
companies. We found that a company which has good profitability indicator always enjoy a high
level of efficiency. We also found that technological innovation,
differentiation and uniqueness can be the complement of DEA for the evaluation of organization
performance. Due to the high level of competition among the companies in this field, they
became a complementary cluster in the overall power industry in Bangladesh.
1.Introduction
KEY PERFORMANCE INDICATORS (KPIs) are typically deployed in organizations improve
productivity (EMMANUEL THANASSOULIS & MARIA CONCEIÇÃO A. SILVA, 2018). A single
KPI rarely captures the whole picture of the organization.

Data Envelopment Analysis (DEA) is a method which enables comparisons where units use
multiple incommensurate resources (‘inputs’) to deliver multiple incommensurate outcomes
(‘outputs’), to yield a single measure of overall performance. Along with the measure, DEA also
yields targets for performance, any gains realizable through changes in scale size and/or mix of
resources used, identification of best practice and benchmark units. Here we outline how DEA
works and indicate some key areas of its use.

The research paper of Charnes and his co-authors introduces DEA as a new approach to
measuring efficiency. Using linear programming assigning weights to certain KPI’s, DEA has
become an effective method in evaluating the organization’s efficiency. DEA constructs a
composite KPI as the ratio of the weighted sum of outputs to a weighted sum of inputs.

What sets DEA apart is that DEA allowing:

(1) to locate inefficient units that require remedial management actions and do more targeted
resource allocation;

(2) reward the more efficient managers;

(3) identify best practices to be introduced into less efficient branches;

(4) set performance targets, among others.

There are three different types of concept in DEA:

THE CONCEPT OF TECHNICAL EFFICIENCY

The concept of DEA efficiency can also be approached through a ‘production space’ route
which has equivalence to the notion of efficiency as a ratio of the sum of weighted outputs to
inputs.

THE CONCEPT OF COST EFFICIENCY

Where we have input prices (or output prices for that matter) we can assess not only technical
but also ‘cost efficiency’. In such a case we would measure the distance of each unit from a
minimum cost frontier.

GAINS THROUGH SCALE SIZE CHANGES

We can understand scale size effects on productivity with the aid of Figure 3, where the
observed units are depicted by. The efficient frontier under constant returns to scale (CRS) is
simply the line passing through C.
2.Literature Review

The efficiency measurement of any individual firm is of fundamental importance for

policymaking in many areas of economics. The efficiency can be measured in terms of
minimization of cost or profit maximization. In general, a firm operates with full efficiency if it’s
able to obtain minimum inputs required to produce any given level of output. There have been a
number of researches that use a nonparametric approach to evaluate the firm performance, but
also, there have been employed in a large body of literature accounting-based financial ratios,
including ROA and ROE as a key indicator to evaluate firm efficiency. For instance, the financial
ratios are employed to determine a firm’s solvency, capital structure, profitability, and liquidity.
Altman stated in his research paper that a firm with a poor profitability ratio record is regarded
as inefficient. Similarly, Penman investigated the properties of the rate of return on equity
(ROE); he concluded that ROE is a pure measure of the firm profitability and performance.
McNamara and Duncan investigated the association between ROA and firm performance. They
found that firm performance is a function of the prior-year ROA.

Since the introduction of data envelopment analysis, (Charnes, 1978) it has been extensively
applied in performance evaluation of different industries and institutes such as schools\hospital
and health care, airport performance, air force maintenance units, power plant, advertising,
transportation, etc. DEA has also been applied in the banking sector in conjunction. with
financial ratios. Halkos and Salamouris used DEA in combination with key financial ratios to
measure the performance of the Greek banking sector. Different scholars have concluded that
data envelopment analysis is superior to financial ratio as a performance measure. Therefore,
they suggested that DEA should be used either an alternative or complement to ratio model for
the evaluation of any business’s performance.

It’s a mathematical liner programming method for assessing the comparative efficiency of
DMU. It can handle multiple inputs and multiple outputs of the decision units as opposed to
other technologies such as ratio model and regress.
3. Data acquisition and methodology
3.1. Data acquisition

The data were obtained from financial statements available in the Bangladesh Stock Exchange
database over the period 2014-2018. It consists of 5 firms from Bangladesh’s power industry.
The firms are grouped in two according to the industry. They only generate electricity. They also
are categorized as small-sized firms owing to their size of average assets and revenue. To
measure the efficiency among them we applied a non-parametric linear programming technique
named DEA Charnes et al. Based on prior study, one input (X1,) and two outputs (Y1, Y2) are
employed. The inputs employed are measured by annual total fixed assets (FA), while the
outputs are measured in terms of annual revenue and operating income (NOI). Accordingly, the
inputs and outputs used
consist of:
X1: Fixed Assets (FA)
Y1: Revenue
Y2: Operating income
3.2 Methodology

DEA

After collecting the data from the financial statements, we used R programming language to
analyze the data. The DEAP software was unable to analyze the data due to technical errors.
Through R we used an input-oriented, constant return to scale (CRS) model.

The Code:

Arguments
X a matrix of inputs for observations, for which DEA scores are estimated.
Y a matrix of outputs for observations, for which DEA scores are estimated.
W a matrix of input prices, only used if model="costmin".
Z a matrix of environmental variables for observations, for which DEA scores are
estimated. Constant is automatically included in Z.
Model a string for the type of DEA model to be estimated, "input" for input-oriented,
"output" for output-oriented, "costmin" for cost-minimization model.
RTS a string for returns-to-scale under which DEA scores are estimated, RTS can be
"constant", "variable" or "non-increasing".
Financial Ratio
(I) Return on assets (ROA) = NPAT / {(AB+AE)/2}

Where:
NPAT is the net profit after taxes; AB is the total assets at the beginning of the period, AE is the
total assets at the end of the period, and S is the total sales. This ratio measures how effectively
the firm’s assets are being used to generate profits. In general, the larger this ratio the better the
firm is performing.

(II) Return on equity (ROE) = NE / SE

Where:
NE is the net earnings after taxes and SE is the shareholder’s equity. It’s a bottom line measure
for the shareholders, measuring the profits earned for each dollar invested in the firm’s stock.
Thus, the higher this ratio the higher is the efficiency.

(III) Net Profit margin = NI / S

Where: NI is the net income, S is the total sales. The higher this ratio the better is the
company’s profitability.
4.Findings

The financial ratios are:

  Khulna Linde Jamuna GBB MJLBD
Fixed Asset 1.62652 0.39579 0.12077 0.45466 0.90998
turnover 6 6 7 9 3

ROA 0.14835 0.0434 0.049 .0403 0.076

ROE 0.22988 0.0674 0.149 .0481 0.203

According to the Financial ratio analysis MJLBD has the highest ROA and ROE making it a
good investment for investors. However, this does not show the true nature of efficiency that the
companies have in their day to day operations. Also the rations require a relative benchmark to
compare to.
As a result, the financial ratios do have a certain level of limitation.
 The DEA analysis:

The received weights:

Khulna Power Linde

Name of GBB Power Company Bangladesh
companies Efficiency Limited: Limited: Limited: Jamuna Oil MJLBD
GBB Power Limited 0.2795 0 0.0455 0 0 0
Khulna Power
Company Limited 1 0 1 0 0 0
Linde Bangladesh
Limited 1 0 0 1 0 0
Jamuna Oil 1 0 0 0 1 0
MJLBD 0.5681 0 1.1237 0.9254 0 0

We can observe from this data that MJLBD and GBB are not efficient.
We shall assign the weights to input to see how much over fixed asset these companies have
used.
  Khulna     MJLBD   GBB  
  Value Lambdas Total   Excess used   Excess used
338435002. 20505596758 1209505860
FA 7438131928 0.0455 7 20167161755 871070857.3
550473440. 18659743619
Revenue 12098317383 0.0455 9 0 549925019 0
Operating 103590572.
Profit 2276715877 0.0455 4 3862479045 0 72562509 0

As we can see Khulna is the efficient. Using its weight and multiplying it with it fixed asset we
will get a total asset used by an efficient firm.
We can observe that MJLBD has an excess of $20167161755 worth of fixed asset that they cannot
use properly. On the other hand, GBB has an excess of $871070857.3 worth of Fixed asset.
Meaning these forms are far from efficient.
Conclusion

Through financial ratio analysis we were able to determine the firms with high ROA, ROE and
Fixed asset turnover. However, this did not depict the whole picture. As we can see two of the 5
power firms were inefficient, when considering its fixed asset as an input.
DEA analysis has allowed us to identify and measure the inefficiencies of different firms in the
industry. Generating more insight than financial ratios.
The two analysis may complement each other, providing investors, managers and other stake
holders more insight on the industry and the firms condition. This makes DEA and financial ratio
analysis an improved alternative to financial ratios.

To conclude, DEA and financial ratio analysis are complementary and this paper has introduced
a how DEA might affect the decision making process.
Reference

1. CHARNES, W.W. COOPER, E. RHODES, 1978 Measuring the efficiency of decision

making units
2. Emmanuel Thanassoulis & Maria Conceição A. Silva (2018) ,Measuring Efficiency
Through Data Envelopment Analysis.
3. EH Ferozl*, S Kim2 and RL Raab1, 2003, “Financial statement analysis: A data
envelopment analysis approach”
4. George E. Halkos ⇑, Nickolaos G. Tzeremes (2011), Industry performance evaluation
with the use of financial ratios: An application of bootstrapped DEA
5. Yaw-Shun Yu a , Ambrosio Barros a & Wen-Hsiang Wu , Chung Hua University , WuFu
Rd., Hsinchu , Taiwan R.O.C Yuan-Pei University , Hsin-Chu , Taiwan R.O.C (2014)
“Data Envelopment Analysis and Financial Ratio: A new approach to estimate the
efficiency of Taiwan Computer's Peripheral Industry