Basic Accounting Financial Analysis

Accounting Equation Matrix
Assets, Expenses Capital, Liabilities, Revenue

To Increase Balance Debit Credit
To Reduce Balance Credit Debit
1 © Ade Omolehinwa, MSc. (Finance), FCA, FCMA, CIIA

ANALYSIS OF WOKING CAPITAL
INTRODUCTION
The working capital of a business is its
current assets less its current liabilities.
Key current assets and current liabilities

include:
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CURRENT ASSETS:
i) Cash
ii) Inventory of raw materials
iii) Inventory of work in progress
iv) Inventory of finished goods
v) Receivables
vi) Marketable securities
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CURRENT LIABILITIES
i) Trade Payables
ii) Tax Payable
iii) Prepayments
iv) Dividend Payable
v) Short term loan
vi) Long term loans maturing within one
year.
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Every business needs adequate liquid
Resources to maintain day-to-day cash
flow. It needs enough to pay wages,
salaries and creditors if it is to keep its
workforce and ensure its suppliers.
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Maintaining adequate working capital is
not just important in the short term.
Adequate liquidity is needed to ensure the
survival of the business in the long term.
Even a profitable company may fail
without adequate cash flow to meet its
liabilities.
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On the other hand, an excessively
conservative approach to working capital
management resulting in high levels of
cash holdings will harm profits because
the opportunity to make a return on the
assets tied up as cash will have been
missed.
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WORKING CAPITAL CYCLE
The connection between investment in
working capital and cash flow may be
illustrated by means of working capital
cycle (also called cash cycle, operating
cycle, or trading cycle).
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THE WORKING CAPITAL CYCLE
CASH PAYABLES
Collections
Purchases
RECEIVABLES
RAW MATERIALS
Sales Production
FINISHED GOODS WORK IN PROGRESS
Production
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The working capital cycle gives the total
length of time between investing cash in
paying for raw materials at the start of
the production process and its recovery
at the end with the collection of cash
from receivables. It is computed using
various accounting ratios.
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raw material inventory
Raw material inventory: × 365 = X
purchases
Payables
Less: Payables: × 365 = (X)
purchases
work in progress
Work in progress: × 365 = X
cost of goods sold
finished goods inventory

Finished goods inventory × 365 = X
cost of goods sold
receivables
Receivables: × 365 = X
sales
Working capital cycle (days) XX
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NOTES
1) Instead of using end of year figures
for the working capital items
(receivables, inventories, payables, etc)
we can also use average figures. Where
the necessary information is available
this should be a better alternative.
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Financial Ratios Analysis
2) Where the degree of completion of
work in-progress is given, the
number of days in work-in-progress
is computed as follows:
×365
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EXAMPLE 01
A company has provided the following information:
Days
Receivables collection period 50
Material holding period 45
Production period (WIP) 20
Payables’ payment period 48
Finished goods holding period 15
Calculate the length of the operating cycle
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SOLUTION
Days
Receivables payment period 50
Raw material holding period 20
WIP period 45
FG holding period 15
Payables’ payment period (48)
Operating cycle 82
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The cash operating cycle is a critical
measure of the overall cash
requirements for working capital.
The amount of cash required to fund the
operating cycle will increase as either:
• the cycle gets longer
• the level of activity/sales increases.
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The length of the cycle depends on how
the balancing act between liquidity and
profitability is resolved, the efficiency of
management and the nature of the
industry.
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EXAMPLE 02
You are provided with the following
financials of Customer plc for the last
three years.
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2018 2019 2020
₦m ₦m ₦m ₦m ₦m ₦m ₦m ₦m ₦m
Net fixed assets 250 245 230
Current assets:
Raw materials 109 150 196
Work-in-progress 76 97 120
Finished goods 85 130 145
Receivables 173 260 300
Bank and Cash 20 5 -
463 642 761 565
Current liabilities:
Trade payables 86 105 126
Bank overdraft - (86) 377 - (105) 537 45 (171) 589
Net capital
employed 627 782 819
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You are also provided with the following
extracts from the company’s trading,
profit and loss accounts.
2018 2019 2020

₦m ₦m ₦m
Sales (10% on cash) 960 1,200 1,320
Cost of goods sold 760 970 1,098
Purchases (80% on credit) 648 878 900
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a) Show, in a tabular form, the working
capital cycle for each year.
b) Comment on your results
c) What actions can be taken by
management to reduce the working
capital cycle?
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SOLUTION
a) We need to work out the following items:
₦m
i) Credit Sales
2018 90% × 960 = 864
2019 90% × 1200 = 1080
2020 90% × 1320 = 1188
ii) CREDIT PURCHASES
2018 80% × 648 = 518.4
2019 80% × 878 = 702.4
2020 80% × 900 = 720
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CALCULATION OF WORKING CAPITAL CYCLE
WC ITEM FORMULA 2018 2019 2020
DAYS DAYS DAYS
Raw materials raw material inventory

× 365 61 62 79
purchases
W. I. P
W. I. P × 365 37 37 40
cost of sales
FG × 365
Finished Goods (FG) 41 49 48
Cost of Sales
Receivables Receivables × 365 73 88 92

Credit Sales
Payables
RM Payables × 365 - 61 - 55 - 64
Credit Purchases
Working Capital Cycle 151 180 195
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b) The working cycle has increased
significantly from 151 days in 2018 to 195
in 2020.
It appears the company has a very
weak control on receivables as credit
period has risen from 73 days to 92 days.
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Although we do not have comparative
industry statistics, the company would
need to take steps to reduce the
working capital cycle.
c) Actions Needed to Reduce Working
Capital Cycle
Possible actions to reduce the working
capital cycle
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1. Reduce raw material inventory by
reducing safety stocks, by making
more frequent orders for smaller
quantities or by reviewing and
improving inventory control
procedures.
Disadvantages:
• Increased probability of stockouts
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• Increased costs, order costs and
other lost bulk order discounts through
sub-optimum order quantities.
2. Delay payments to Creditors:
Disadvantages:
• Loss of goodwill,
• Loss of suppliers
• Increased unit cost of purchases
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• Loss of cash discounts
3. Select suppliers which give greater
credits
Disadvantages:
• Inferior quality of goods
• Less reliable supply
• Increased unit cost of purchases
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4. Reduce work in progress by taking
the following steps
• Improving the manufacturing
systems in terms of machine layouts,
materials routing, and resource balancing
• Improving the interface between
production and marketing staff.
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• Effective preventative maintenance
thus reducing machine downtime.
• Effective quality control policy and
procedures, including possible use of
total quality control concepts, thus
reducing the level of rework and time
wasted.
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• Efficient stock control systems,
speeding up issue of stock and reducing
the incidence of stockouts.
• Improving productivity (e.g. by the
use of labour incentives).
• Automation, where applicable and if
cost justified.
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• Improving labour quality - training,
incentives, leadership, and working culture
generally.
• Reducing, if possible, the variety of
materials, components and tasks involved in
the production of different products, with a
move towards standardisation of
material/components and variety reduction in
general
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Disadvantages
• Cost of capital investment
• Human and practical problems of
making changes
5. Reduce finished goods inventory
Disadvantage:
• Difficulty of supplying customers
promptly, leading to a loss of sales
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6. Reduce credit period offered to
customers.
Disadvantage:
• Reduction in sales
7. Offer cash discounts to encourage
early payment
Disadvantages:
• Cost of the discounts
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• Possibility of customers taking the
discount yet still paying late
8. Improve the collection of overdue
balances:
Disadvantages:
• Cost of improved credit control
• Reduction of customers’ goodwill
• Loss of sales
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Ademola Omolehinwa & Co
Training
ASSESSING FINANCIAL HEALTH OF A FIRM WITH RATIO ANALYSIS: ABC PLC

ABC Ltd is a leading producer and exporter of engineering items such as steel pipes, ingots, billets,
etc. It has also recently added a chemical plant and a paper plant as part of its diversification strategy.
The number of shares outstanding is 22,500,000. The financial data for the company are given in the
following tables.
TABLE 01: PROFIT OR LOSS ACCOUNT FOR YEAR ENDED 31 DECEMBER

2011 2012 2013
N
= 000 N
= 000 N
= 000
A. Sales 233,890 282,569 371,723
B. Cost of goods sold 192,904 232,280 305,366
C. Gross profit = (A-B) 40,986 50,289 66,357
D. Less: Selling and admin expenses 23,972 26,210 35,787
E. Operating income = (C-D) 17,014 24,079 30,570
F. Add: Other income 1,524 2,538 3,691
G. Earnings before interest and tax
(EBIT) = (E + F) 18,538 26,617 34,261
H. Less: Interest 5,984 12,498 14,346
I. Profit before tax (PBT) = (G -H) 12,554 14,119 19,915
J. Income tax 4,179 3,000 6,429
K. Profit after tax (PAT) = (I-J) 8,375 11,119 13,486
L. Dividend 3,375 3,938 4,500
M. Retained earnings = (K-L) 5,000 7,181 8,986
TABLE 02: STATEMENT OF COST OF GOODS SOLD

2011 2012 2013
N
= 000 N
= 000 N
= 000
Raw Material 158,734 201,954 275,152
Direct labour 13,813 17,086 22,894
Depreciation 2,307 3,864 4,159
Other production expenses 20,534 25,572 32,944
1,95,388 248,476 335,149
Add: Opening work-in-process 5,709 8,574 15,055
201,097 257,050 350,204
Less: Closing work-in-process 8,574 15,055 23,083
Cost of Production 192,523 241,995 327,121
Add: Opening finished inventory 15,093 14,712 24,426
207,616 256,707 351,547
Less: Closing finished inventory 14,712 24,426 46,181
Cost of Goods Sold 192,904 232,281 305,366
ZENITH BANK 1 Financial Ratio Analysis

Training
TABLE 03: STATEMENT OF FINANCIAL POSITION
2011 2012 2013

N
= ’000 N
= ’000 N
= ’000
Non- Current Assets:
Property, Plant and Equipment
Cost 70,625 85,808 98,227
Less: Depreciation 15,955 19,446 23,544
Carrying Amount 54,670 66,362 74,683
Current Assets
Inventories:
Raw Material 24,342 38,406 45,774
Work-in- process 8,574 15,055 23,084
Finished goods 14,712 24,428 46,181
47,628 77,889 115,039
Receivables 25,316 34,061 48,318
Cash and bank balances 837 9,884 2,608
Others 12,827 18,621 21,127
Total current assets 86,608 140,455 187,092
Total Assets 141,278 206,817 261,775
Equity and Liabilities

Equity
Share Capital 22,500 22,500 22,500
Reserve 28,612 35,795 44,781
Total Equity 51,113 58,295 67,281
Non -Current Liabilities

Long-term notes 19,987 36,165 38,919
Total Non-Current Liabilities 19,987 36,165 38,919
Current Liabilities
Trade Payables 3,599 21,121 33,935
Short-term bank notes 44,292 64,139 83,987
Others 22,287 27,097 37,653
Total Current Liabilities 70,178 112,357 155,575
Equity and Liabilities 141,278 206,817 261,775
ZENITH BANK 2 Financial Ratio Analysis

EVALUATING QUALITY OF FINANCIAL REPORT
Introduction
The ability to assess the quality of reported financial
information can be a valuable skill. An analyst or a
lending banker who can recognise high-quality
financial reporting can have greater confidence in
analysis based on those financial reports and the
resulting investment/lending decisions.
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Reporting quality pertains to the information
disclosed in financial reports. High-quality
reporting provides decision-useful
information–information that is relevant and
faithfully represents the economic reality of
the company’s activities during the reporting
period and the company’s financial condition at
the end of the period.
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This is a very wide (and practical) area in
financial analysis. We cannot go too far because
of time and the very little knowledge of
accounting we have just acquired.
How to Evaluate Quality of a Company’s
Financial Reports
Steps in evaluating the quality of financial
reports:
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Step 1: Understand the company, its industry,
and the accounting principles it uses and why
such principles are appropriate.
Step 2: Understand management including the
terms of their compensation.
Step 3: Identify material areas of accounting
that are vulnerable to subjectivity.
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Step 4: Make cross-sectional and time series
comparisons of financial statements and
important ratios.
Step 5: Check for warning signs as detailed
elsewhere below.
Indicators of Earnings Quality
High-quality earnings are characterised by two
elements:
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1. Sustainable: high-quality earnings tend to
persist in the future.
2. Adequate: high-quality earnings cover the
company's cost of capital.
High–quality earnings assume high-quality
reporting. In other words, low-quality earnings
come about due to
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(a) earnings that are below the firm's cost of
capital and/or
(b) earnings that are not sustainable and/or
(c) poor reporting quality.
(i.e., the reported information does not provide a
useful indication of a firm's performance).
Sustainable or persistent earnings are earnings
that are expected to recur in the future.
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Earnings comprised of a high proportion of non-
recurring items are considered to be non-
sustainable (and hence low-quality).
Classification of items as non-recurring is highly
subjective and, hence, is open for gaming.
Classification shifting does not affect the total
net income but rather is an attempt to mislead
the user of the financial statements
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into believing that the "core" or "recurring"
portion of earnings is higher than it actually is.
One way to overstate persistent earnings is to
mis-classify normal operating expenses as
expenses from discontinued operations.
Analysts should be wary of large special items or
when the company is reporting unusually large
operating income for a period.
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Accounting Choices and Impact on Quality of
Earnings
▪ Aggressive, premature, and fictitious revenue
recognition results in overstated income and
thus overstated equity. Assets, usually
accounts receivable, are also overstated.
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▪ Conservative revenue recognition, such as
deferred recognition of revenue, results in
understated net income, understated equity,
and understated assets.
▪ Omission and delayed recognition of expenses
results in understated expenses and overstated
income, overstated equity, overstated assets,
and/or under-stated liabilities.
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An understatement of bad debt expense results
in overstated accounts receivable. Understated
depreciation or amortisation expense results in
the overstatement of the related long-lived
asset. Understated interest, taxes, or other
expenses result in the understatement of the
related liability: accrued interest payable, taxes
payable, or other payable.
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▪ Understatement of contingent liabilities is
associated with overstated equity resulting
from understated expenses and overstated
income or overstated other comprehensive
income.
▪ Overstatement of financial assets and
understatement of financial liabilities, reported
at fair value,
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are associated with overstated equity resulting
from over-stated unrealised gains or
understated unrealised losses.
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Some Accounting Warning Signals
Potential Issues Possible Actions/Choices Warning Signals
Overstatement or non-sustainability of Contingent sales with right of return, ▪ Growth in revenue higher than that of
operating income and/or net income "channel stuffing" (the industry or peers
▪ Overstated or accelerated practice of inducing customers to order ▪ Increases in discounts to and returns
revenue recognition products they would from customers
▪ Understated expenses otherwise not order or order at a later ▪ Higher growth rate in receivables
▪ Misclassification of revenue, date through generous than revenue
gains, expenses, or losses. terms), "bill and hold" sales ▪ Large proportion of revenue in final
(encouraging customers to order goods quarter of year for a non-seasonal
Misstatement of balance sheet and retain them on seller's premises) business
items (may affect income ▪ Classifying non-operating income or ▪ Inconsistency over time in the items
statement) gains as part of operations included in operating revenues and
▪ Over- or understatement of ▪ Classifying ordinary expenses as non- operating expenses
assets recurring or non-operating ▪ Increases in operating margin
▪ Over- or understatement of ▪ Choice of models and model inputs ▪ Aggressive accounting
Liabilities to measure fair value assumptions, such as long,
▪ Misclassification of assets ▪ Classification from current to non- depreciable lives.
and/or liabilities. current
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Potential Issues Possible Actions/Choices Warning Signals
▪ Over- or understating provision ▪ Losses in non-operating income or
for bad debt other comprehensive income and
gains in operating income or net
income
▪ Compensation largely tied to
financial results
▪ Models and model inputs that bias
fair value measures
▪ Inconsistency in model inputs
when measuring fair value of assets
compared with that of liabilities
▪ Typical current assets, such as
accounts receivable and inventory,
included in non-current assets
▪ Provision for bad debt that
fluctuate over time or are not
comparable with peers.
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Life Case Study Sunbeam Corporation
Premature/Fraudulent Revenue Recognition
Sunbeam Corporation was a consumer goods
company focused on the production and sale of
household appliances and outdoor products. In
the mid- to late 1990s, it appeared that its new
CEO, "Chainsaw AI" Dunlap, had engineered a
turnaround at Sunbeam.
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He claimed to have done this through cutting
costs and increasing revenues. The reality was
different. Had more analysts performed basic
but rigorous analysis of the financial statements
in the earlier phases of Sunbeam's misreporting,
they might have been more skeptical of the
results produced by Chainsaw AI. Sunbeam
engaged in numerous sales transactions
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inflated revenues. Among them were the
following:
▪ Sunbeam included one-time disposals of
product lines in sales for the first quarter of
1997 without indicating that such non-recurring
sales were included in revenues.
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▪ At the end of the first quarter of 1997 (March),
Sunbeam booked revenue and income from a sale
of barbecue grills to a wholesaler. The wholesaler
held the merchandise over the quarter's end
without accepting ownership risks. The
wholesaler could return the goods if it desired,
and Sunbeam would pick up the cost of shipment
both ways.
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All of the grills were returned to Sunbeam in the
third quarter of 1997.
▪ Sunbeam induced customers to order more
goods than they would normally through offers
of discounts and other incentives. Often, the
customers also had return rights on their
purchases. This induced ordering had the effect
of inflating current results by pulling future
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sales into the present. This practice is
sometimes referred to as “channel stuffing.”
This policy was not disclosed by Sunbeam, which
routinely made use of channel-stuffing practices
at the end of 1997 and the beginning of 1998.
▪ Sunbeam engaged in bill-and-hold revenue
practices. In a bill-and-hold transaction,
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revenue is recognized when the invoice is issued
while the goods remain on the premises of the
seller. These are unusual transactions, and the
accounting requirements for them are very
strict: The buyer must request such treatment,
have a genuine business purpose for the
request, and must accept ownership risks.
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Other criteria for justifying the use of this
revenue recognition practice include the seller's
past experience with bill-and-hold transactions,
in which buyers took possession of the goods
and the transactions were not
reversed.
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There was no real business purpose to the
channel stuffing and bill-and-hold transactions at
Sunbeam other than for the seller to accelerate
revenue and for the buyers to take advantage of
such eagerness without any risks on their part.
In the words of the SEC, , "these transactions
were little more than projected orders disguised
as sales" (SEC 2001a).
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Sunbeam did not make such transactions clear
to analysts, and many of its disclosures from the
fourth quarter of 1996 to the middle of 1998
were inadequate. Still, its methods of inflating
revenue left indicators in the financial
statements that should have alerted analysts to
the low quality of its earnings and revenue
reporting.
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If customers are induced into buying goods they
do not yet need through favorable payment
terms or given substantial leeway in returning
such goods to the seller, days' sales outstanding
(DSO) may increase and returns may also
increase.
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Furthermore, increases in revenue may exceed
past increases and the increases of the industry
and/or peers. Problems with and changes in
collection, expressed through accounts
receivable metrics, can give an analyst clues
about the aggressiveness of the seller in making
sales targets.
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Table 1 contains relevant annual data on
Sunbeam's sales and receivables from 1995
(before the misreporting occurred) through 1997
(when earnings management reached its peak
level in the fourth quarter).
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Table 1 Information on Sunbeam's Sales and Receivables, 1995 - 1997
($ millions) 1995 1996 1997
Total revenue $1,016.9 $984.2 $1,168.2
Change from prior year – 3.2% 18.7%
Gross accounts receivable $216.2 $213.4 $295.6
Change from prior year –1.3% 38.5%
Receivables/revenue 21.3% 21.7% 25.3%
Change in receivables/revenue 0.7% 0.4% 3.6%
Days' sales outstanding 77.6 79.1 92.4
Accounts receivable turnover 4.7 4.6 4.0
Source: Based on information in original company 10-K filings.
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What can an analyst learn from the information
in Table 1?
▪ Although revenues dipped 3.2% in 1996, the
year the misreporting began, they increased
significantly in 1997 as Sunbeam's various
revenue "enhancement" programs were
implemented.
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The important factor to notice–the one that should
have given an analyst insight into the quality of the
revenues–is the simultaneous, and much greater,
increase in the accounts receivable balance.
Receivables increasing faster than revenues
suggests that a company may be pulling future
sales into current periods by offering favorable
discounts or generous return policies.
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As it turned out, Sunbeam offered all of these
inducements.
▪ The percentage relationship of receivables to revenue
is another way of looking at the relationship between
sales and the time it takes a company to collect cash
from its customers. An increasing percentage of
receivables to revenues means that a lesser
percentage of sales has been collected.
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The decrease in collection on sales may indicate
that customers' abilities to repay have
deteriorated. It may also indicate that the seller
created period-end sales by shipping goods that
were not wanted by customers; the shipment
would produce documentation, which serves as
evidence of a sale. Receivables and revenue
would increase by the same absolute amount,
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which would increase the percentage of
receivables to revenue. Customers would return
the goods to the seller in the following
accounting period. The same thing would happen
in the event of totally fictitious revenues.
Revenues from a non-existent customer would
simultaneously increase receivables by the same
amount.
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An increase in the relationship between revenue
and receivables provides analysts with a clue
that collections on sales have declined or that
there is a possible issue with revenue
recognition.
▪ The number of days sales outstanding
[Accountsreceivable/(Revenues/365)]
increased each year,
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indicating that the receivables were not being
paid on a timely basis-or even that the revenues
may not have been genuine in the first place.
DSO figures increasing over time indicate that
there are problems, either with collection or
revenue recognition. The accounts receivable
turnover (365/DSO) tells the same story in a
different way:
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It is the number of times the receivables
converted into cash each year, and the figure
decreased each year. A trend of slower cash
collections, as exhibited by Sunbeam, shows
increasingly inefficient cash collections at best
and should alert an analyst to the possibility of
questionable sales or revenue recognition
practices.
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▪ The accounts receivable showed poor quality. In 1997,
it increased 38.5% over the previous year, while
revenues gained 18.7%. The simple fact that
receivables growth greatly outstripped the revenue
growth suggests receivables collection problems.
Furthermore, analysts who paid attention to the notes
might have found even more tiles to fit into the
mosaic of accounting manipulations.
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According to a note in the 10-K titled “Accounts
Receivable Securitization Facility,” in December
1997 Sunbeam had entered into an arrangement
for the sale of accounts receivable. The note said
that “At December 28, 1997, the Company had
received approximately $59 million from the sale
of trade accounts receivable.”
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Those receivables were not included in the year-
end accounts receivable balance. As the pro
forma column in Table 2 shows, the accounts
receivable would have shown an increase of
66.1% instead of 38.5%; the percentage of
receivables to sales would have ballooned to
30.4%, and the days' sales outstanding would
have been an attention-getting 110.8 days.
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Had this receivables sale not occurred, and the
receivables been that large, perhaps analysts
would have noticed a problem sooner. Careful
attention to the notes might have alerted them to
how this transaction improved the appearance of
the financial statements and ratios.
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Table 2 Information on Sunbeam's Sales and Receivables, 1995 - 1997
1997 Pro Forma
($ millions) 1995 1996 1997

Total revenue $1,016.9 $984.2 $1,168.2 $1,168.2
Change from prior year – 3.2% 18.7% 18.7%
Gross accounts receivable $216.2 $213.4 $295.6 $354.6

Change from prior year –1.3% 38.5%
66.1%
Receivables/revenue 21.3% 21.7% 25.3%

30.4%
Change in receivables/revenue 0.7% 0.4% 3.6%

8.7%
Days' sales outstanding 77.6 79.1 92.4

110.8
Accounts receivable turnover 4.7 4.6 4.0

3.2
Source: Based on information in original company 10-K filings.
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Financial Instruments
ADEMOLA OMLEHINWA & CO
There are three relevant Standards on financial instruments which
are:
IAS 32 Financial instruments: Presentation, which deals with: The
classification of financial instruments between liabilities and equity
Presentation of certain compound instruments
IFRS 7 Financial instruments: Disclosures, which revised,
simplified and incorporated disclosure requirements previously in IAS
32.
IFRS 9 Financial Instruments, which actually replaced IAS 39
measurement and recognition.
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IFRS 9 - Briefing note
One of the major outcomes of the global financial crisis of 2007 to
2008 was a fundamental review of how banks account for loan losses.
The new accounting standard, IFRS 9 Financial Instruments, will require
banks to show their losses earlier than in the past. Overall, the losses
themselves do not change in total over the life of the loans; only the
timing of their recording by the bank will be different. The new
approach is seen as more timely and it reflects the underlying
economics more closely since expected future losses are already
priced in the interest rate charged on the loans.
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This is a complex area and it has taken time to make sure the new rules
are fit for purpose. The financial services industry in Nigeria is devoting
immense resources for the implementation of the standard.
This is what banks do

The main activity of banks is to lend to people and businesses. When
they do, the amount owed back to the bank is shown as an asset (a
“receivable”) on the bank’s statement of financial position: this is
because it will be repaid to the bank at a later date. The bank charges
interest on the loans, priced to reflect the risk of non-payment, as well
as market rate of interest; this is shown in the profit or loss account as
income.
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Typically, the monthly amounts paid by the borrower include both
capital and interest. The bank records this by reducing the amount
owed by the customer (for the capital element) and showing the
interest income in its profit or loss account.
In line with accounting rules, if the bank thinks that it will not recover
the full amount of the loan, it has to reduce the asset in its financial
statements and take a loss against it. For example, if a bank lends
₦100,000 but later thinks it will collect only ₦80,000, it must show a
loss of ₦20,000 in its profit or loss account and show the net asset as
₦80,000 in the statement of financial position.
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This is accounting for lending in its simplest form. Of course banks have
many types of loans, including mortgages, credit card balances and
commercial loans.
Changes needed
Before IFRS 9, accounting rules forced banks to “wait” for a loss event
before recording a loss against a loan asset. This was the case even
when banks expected that a percentage of their loans would not be paid
back in full. When the downturn came they had to catch up by recording
significantly larger losses all at once. The result was the heavy
criticism of banks during the financial crisis for providing “too little too
late”.
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After long discussions it was agreed that this was not helpful; losses
should be booked when they are expected as well as when they actually
occur. Accounting rules have been changed under IFRS 9 in order to
anticipate losses from the day the loan is granted: this is what
accountants mean by moving from an “incurred loss model” (which
needs an event to occur before a loss is recorded) to an “expected loss
model”.
The expected loss model in IFRS 9 is complex and it requires banks to

look into the future and to estimate the range of possible economic
scenarios that might occur. Banks will have to decide what they think is
going to happen to their customers and when. Although this will be done
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on a portfolio rather than individual borrowing level, they have to
consider different circumstances, wider economic events and extreme
conditions. This may sound onerous but anticipating future losses in
this way will promote more prudent (i.e. later) recording of profits on
the loans.
It is helpful to understand that the estimate of losses at any point in

time remains an estimate. It is also worth noting that unforeseen future
events cannot, by definition, be factored into these calculations, so
economic shocks can still cause significant and sudden additional
losses. This is one of the reasons banks have to hold substantial buffers
of capital to absorb such losses if they arise.
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The expected effect
The overall impact of IFRS 9 will be that banks will report their losses
sooner, but these are not new losses. They have been reflected in the
lending decisions and only the timing of their recognition is affected.
While this treatment is more prudent, there are some real challenges.
Measurement is highly subjective because it relies on an estimate. This
element of forecasting will potentially lead to volatile results. When
recession is predicted losses will accelerate, even if current economic
circumstances are favourable. Comparison between banks will be
difficult since their view of the future could be radically different.
Analysts looking at bank financial statements may find this problematic.
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Disclosures
Disclosures in financial statements will be of key importance. Providing
enough information on year-on-year changes, assumptions and
projections will be vital to allow users to compare one bank with
another where different assessments of the future have been used in
the expected loss calculations.
It is going to take time for the rules to bed down, and for people reading
bank financial statements to understand them.
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Definitions
1. Financial instrument: This is any contract that gives rise to both a
financial asset to one entity and a financial liability or equity
instrument to another entity.
2. Financial asset: This is any asset that is cash or equity instrument
of another entity (e.g. shares of another entity). It can equally be
described as a contractual right to receive cash or another financial
asset from another entity; or to exchange financial instruments with
another entity under conditions that are potentially favourable to
the entity.
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3. Financial liability: This is any liability that is a contractual obligation
to deliver cash or another financial asset to another entity. It can
also be referred to as a contractual obligation to exchange financial
instruments with another entity under conditions that are potentially
unfavourable; or a contract that will or may be settled in the entity's
own equity.
4. Equity instrument: This is any contract that evidences a residual
interest in the assets of an entity after deducting all of its liabilities.
5. Compound financial instruments: These are financial instruments
that contain both a liability and an equity element.
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6. Primary instruments: These are financial instruments such as
receivables, payables and equity securities.
7. Credit risk: This is the risk that one party to a financial instrument
will cause a financial loss for the other party by failing to discharge
or fulfill its obligation.
8. Liquidity risk: This is the risk that an entity will encounter difficulty
in meeting obligations associated with financial liabilities. That is, the
risks of loss to an investor from the inability to sell a security to
another investor at a price close to its true value.
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9. Market risk: This is the risk that the fair value or future cash flows
of a financial instrument will change in value (i.e. fluctuates) as a
result of changes in market prices.
10.Past due: A financial asset is past due when a counterparty has
failed to make a payment when contractually due.
11. Loans payable: Loans payable are financial liabilities, other than
short-term trade payables on normal credit terms.
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Analysis of Financial Instruments Contracts
Remember that for a contract to result to financial instruments, the
contract must give rise to both a financial asset to one entity and a
financial liability or equity instrument to another entity. If this condition
is not met, then the contract is not a financial instrument. The examples
below should assist you in understanding what a financial instrument is.
Examples of Financial Instruments Contracts

The following are some of the examples of financial instruments
contracts:
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1. Customers deposit: This is a financial instrument contract because
it will give rise to financial asset (amount receivable) to the
customer and also give rise to financial liability (deposit liability) to
the bank.
2. Loans and advances to customers: This is a financial instrument
contract because it will give rise to financial asset (amount
receivable) to the bank and also give rise to financial liability
(amount payable) to the customers.
3. Inter-bank placements: This is a financial instrument contract
because it will give rise to financial asset (amount receivable) to the
lending bank and also give rise to financial liability (amount payable)
to the receiving bank.
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4. Credit sales (not cash sales): This is a financial instrument
contract because it will give rise to financial asset (trade
receivable) to the seller and also give rise to financial liability (trade
payable) to the buyer.
5. Bank savings (including all forms of bank deposits): This is a
financial instrument contract because it will give rise to financial
asset (amount receivable from the bank) to the depositor (bank’s
customer) and also give rise to financial liability (amount payable to
the customer) to the bank.
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6. Loan transaction (both from banks and other sources): This is a
asset (loan receivable) to the lender and also give rise to financial
liability (loan payable) to the borrower.
7. Purchase of treasury bills: This is a financial instrument contract
because it will give rise to financial asset (treasury bills investment)
to the buyer or investor and also give rise to financial liability
(amount refundable) to the issuer (usually the government).
8. Purchase of bonds: This is a financial instrument contract because
it will give rise to financial asset (bonds investment) to the buyer or
investor and also give rise to financial liability (amount refundable)
to the issuer (may be the government or a public company).
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9. Ordinary shares (or equity shares) transaction: This is a
asset (share investment) to the buyer or investor and also give rise
to equity instruments (not financial liability) known as equity capital
to the issuer (i.e. the company issued the shares).
Example 1
The following relates to ABC for the year ended 31 December 2019
a. ABC owns cash in the amount of ₦5,000
b. ABC owns a demand deposit in the amount of ₦20,000 with Zenith
bank.
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c. ABC's statement of financial position includes ₦10,000 shares of
UBA.
d. ABC's statement of financial position includes inventory of ₦35,000
e. ABC sold goods amounting to ₦12,000 to Mr John on credit.
f. On 22 December 2019, ABC received an advance payment of
₦40,000 from one of its customers, Miss Benson to deliver goods in
January 2020.
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Required:
Determine whether the items above are financial assets or financial
liabilities and also state whether a financial instrument exist as at 31
December 2019.
Solution
a. Currency (cash) is a financial asset because it represents the
medium of exchange and is therefore the basis on which all
transactions are measured. Therefore, the cash of ₦5,000 is a
financial asset but there is no financial instrument because the
₦5,000 is not a financial liability or equity instrument to another
party.
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b. The demand deposit of ₦20,000 is a financial asset because it
represents the contractual right of the depositor to obtain cash
from the Zenith bank. The demand deposit balance of ₦20,000 is a
financial asset to ABC and also a financial liability to Zenith bank.
Therefore, this is a financial instrument contract.
c. The ₦10,000 shares of UBA represent equity investment of ABC. The
₦10,000 share investment in UBA is a financial asset to ABC and
also an equity instrument (not financial liability) to UBA. Therefore,
this is a financial instrument contract.
d. The sale of inventory will certainly give rise to financial asset in form
of cash or receivable but inventory on its own is not a financial
asset.
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e. The credit sales of ₦12,000 is a financial instrument contract
because it has given rise to financial asset (trade receivable) to ABC
and financial liability (trade payable) to Mr John.
f. This is not a financial instrument because ABC only has an obligation
to deliver goods (and not cash or another financial asset). Obligation
to deliver physical asset are not financial liability and does not
financial instrument.
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ADEMOLA OM0LEHINWA & CO
FINANCIAL RATIO ANALYSIS

Nature of Ratio Analysis

Ratio analysis is a powerful tool of
financial analysis. In financial analysis, a
ratio is used as a benchmark for
evaluating the financial position and
performance of a firm.
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The absolute accounting figures

reported in the financial statements do
not provide a meaningful understanding
of the performance and financial
position of a firm. An accounting figure
conveys meaning when it is related to
some other relevant information.
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For example, a net profit of N20m may look

impressive, but the firm’s performance can
be said to be good or bad only when the net
profit figure is related to the firm’s
investment. The relationship between two
accounting figures, expressed mathema-
tically, is known as a financial ratio (or
simply as a ratio).
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Ratios help to summarise large

quantities of financial data and to make
qualitative judgement about the firm’s
financial performance. For example,
consider current ratio (discussed in
detail later on). It is calculated by
dividing current assets by current
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liabilities; the ratio indicates a relationship

- a quantified relationship between
current assets and current liabilities.
This relationship is an index or yardstick
which permits a qualitative judgement to
be formed about the firm’s ability to meet
its current obligations.
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It measures the firm’s liquidity. The

greater the ratio, the greater the firm’s
liquidity and vice versa. The point to note
is that a ratio reflecting a qualitative
relationship, helps to form a qualitative
judgement. Such is the nature of all
financial ratios.
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Standards of Comparison
Ratio analysis involves comparison for a
useful interpretation of the financial
statements. A single ratio in itself does not
indicate favourable or unfavourable
condition.
It should be compared with some standard.
Standards of comparison may consist of:
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Time Series Analysis

When financial ratios over a period of
time are compared, it is known as time
series (or trend) analysis. It gives an
indication of the direction of change and
reflects whether the firm’s financial
performance has improved, deteriorated
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or remained constant over time. The

analyst should not simply determine the
change, but, more importantly, he/she
should understand why ratios have
changed. The change, for example, may be
affected by changes in the accounting
policies without a material change in the
firm’s performance.
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Cross-sectional Analysis
Another way of comparison is to compare
ratios of one firm with some selected firms in
the same industry at the same point in time.
This kind of comparison is known as the cross-
sectional analysis. In most cases, it is more
useful to compare the firm’s ratios with ratios
of a few carefully selected competitors, who
have similar operations.
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This kind of a comparison indicates

the relative financial position and
performance of the firm. A firm can
easily resort to such a comparison,
as it is not difficult to get the
published financial statements of the
similar firms.
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Industry Analysis
To determine the financial condition
and performance of a firm, its ratios
may be compared with average ratios
of the industry of which the firm is a
member.
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This sort of analysis, known as the industry

analysis, helps to ascertain the financial
standing and capability of the firm vis-’a-
vis’ other firms in the industry. Industry
ratios are important standards in view of
the fact that each industry has its
characteristics which influence the
financial and operating relationships.
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But there are certain practical

difficulties in using the industry ratios.
First, it is difficult to get average ratios
for the industry. Second, even if industry
ratios are available, they are averages -
averages of the ratios of strong and
weak firms.
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Sometimes differences may be so

wide that the average may be of little
utility. Third, averages will be
meaningless and the comparison
futile if firms within the same
industry widely differ in their
accounting policies and practices.
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If it is possible to standardise the

accounting data for companies in the
industry and eliminate extremely strong
and extremely weak firms, the industry
ratios will prove to be very useful in
evaluating the relative financial
condition and performance of a firm.
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Pro Forma Analysis
Sometimes future ratios are used as the standard
of comparison. Future ratios can be developed
from the projected, or pro forma, financial
statements. The comparison of current or past
ratios with future ratios shows the firm’s relative
strengths and weaknesses in the past and the
future. If the future ratios indicate weak financial
position, corrective actions should be initiated.
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COMMON RATIOS USED IN FINANCIAL

ANALYSIS
There are large number of ratios that can
be calculated from any financial state-
ments.
It is however helpful to think about ratios
in terms of broad categories based on
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what aspects of performance a ratio

is intended to detect.
Financial analysts use a variety of
categories to classify ratios. The
category names and the ratios
included in each category can differ.
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The common categories are itemized

below:
1. ACTIVITY RATIOS
These ratios measure how efficiently a
company performs day-to-day tasks,
such as the collection of receivables
and management of inventory.
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2. LIQUIDITY RATIOS
These ratios measure the company’s
ability to meet its short-term obligations.
3. SOLVENCY RATIOS
Solvency ratios measure a company’s
ability to meet long-term obligations.
Subsets of these ratios are also known as
“leverage” and “long-term debt” ratios.
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4. PROFITABILITY RATIOS
These ratios measure the company’s ability
to generate profitable sales from its
resources (assets).
5. VALUATION RATIOS
Valuation ratios measure the quantity of an
asset or flow (e.g. earnings) associated
with ownership of a specified claim (e.g., a
share or ownership of the enterprise).
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These categories are not mutually exclusive; some

ratios are useful in measuring multiple aspects of
the business. For example, an activity ratio
measuring how quickly a company collects
accounts receivable is also useful in assessing
the company’s liquidity because collection of
revenues increases cash. Some profitability ratios
also reflect the operating efficiency of the
business.
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INTERPRETATION AND CONTEXT

Financial ratios can only be interpreted in
the context of other information, including
benchmarks. As already noted at the
beginning of this paper, the financial ratios
of a company are normally compared with
those of its major competitors (cross-
sectional)
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and to the company’s prior periods (trend

analysis). The goal is to understand the
underlying causes of divergence between a
company’s ratios and those of the industry. Even
ratios that remain consistent require under-
standing because consistency can sometimes
indicate accounting polices selected to smooth
earnings. An analyst should evaluate financial
ratios based on the following:
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1. Company Goals and Strategy

Actual ratios can be compared with
company objectives to determine whether
objectives are being attained and whether
the results are consistent with the
company’s strategy.
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2. Industry Norms (Cross-Sectional

Analysis)
When industry norms are used to
make judgements, care must be taken
because:
i) Many ratios are industry specific, and
not all ratios are important to all
industries.
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ii) Companies may have several different lines

of business. This will cause aggregate
financial ratios to be distorted. It is better
to examine industry- specific ratios by lines
of business.
iii) Differences in accounting methods used by
companies can distort financial ratios.
iv) Differences in corporate strategies can
affect certain financial ratios.
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ACTIVITY RATIOS
Activity ratios are also known as asset
utilisation ratios or operating efficiency
ratios. This category is intended to
measure how well a company manages
various activities, particularly how
efficiently it manages its various assets.
30 ZENITH BANK Financial Ratios Analysis
Activity ratios are analysed as indicators
of ongoing operational performance. -
how effectively assets are used by a
company.
They reflect the efficient management of
both working capital and longer term
assets.
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As noted, efficiency has a direct impact
on liquidity (the ability of a company to
meet its short-term obligations), some
activity ratios are also useful in
assessing liquidity.
Most commonly used activity ratios include:
1. Inventory (stock) turnover (ST)
2. No of days stock held (NSH)
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3. Receivable Turnover (RT)
4. Average collection period (ACP)
5. Payable Turnover (PT)
6. Number of days credit received from
creditors (NCR)
7. Working capital turnover (WCT)
8. Non-Current asset turnover (FAT)
9. Total asset turnover (TAT)
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TABLE 04: BELOW SHOWS THE NUMERATOR AND
DENOMINATOR OF EACH RATIO
Activity Ratios Numerator Denominator
1. ST Cost of goods sold Average Inventory
(stock)
2. NSH Number of days in periods ST
3. RT TR Average receivables
4. NCG Number of days in period RT
5. PT Purchases Average Payables
6 NCR Number of days in period PT
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7. WCT TR Average working capital
8. NCAT TR Average net non-current
asset
9. TAT TR Average total assets.
Notes: TR = Total Revenue (Sales)
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Net Non-Current Asset = the carrying
amount of the asset.
Activity ratios measure how efficiently the
company utilises assets. They usually
combine information from the income
statement in the numerator with Statement
of Financial Position (SFP) items in the
denominator.
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Because the income statement measures
what happened during a period whereas the
SFP shows the condition only at the end of
the period, average SFP data are normally
used for consistency. For example, to
measure inventory management efficiency,
cost of goods sold (from the income
statement) is divided by average inventory
(from the SFP).
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STOCK TURNOVER (ST)
Cost of goods sold
Average inventory
The average inventory is the average of
opening and closing balances of inventory.
In a manufacturing company inventory of
finished goods is used to calculate
inventory turnover.
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For ABC Plc, the average finished goods
inventory is:
24426 + 46181 = 35,305.50
2
Thus, the ST is
N305366 = 8.6 times
N35303.50
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Closely related to this ratio is the number
days stock held (NSH):
NSH = Number of days in period = 365
= 42 days
ST 8.6
This ratio can also be computed as follows
Average stock 35303.50
NSH = = X 365 = 42 days
Cost of goods sold 305366
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The higher the inventory turnover ratio, the
shorter the period that inventory is held
and so the lower the NSH. In general,
inventory turnover (and NSH) should be
bench-marked against industry norms.
A high inventory turnover ratio relative to
industry norms might indicate highly
effective inventory management.
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Alternatively, a high inventory turnover
ratio (and commensurately, low NSH) could
possibly indicate the company does not
carry adequate inventory, so shortages
could potentially hurt revenue. To assess
which explanation is more likely, the analyst
can compare the company’s revenue
growth with that of the industry.
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Slower growth combined with higher inven-
tory turnover could indicate inadequate
inventory levels. Revenue growth at or
above the industry’s growth supports the
interpretation that the higher turnover ref-
lects greater inventory management effici-
ency.
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COMPONENTS OF INVENTORY
The manufacturing firm’s inventory consists
of two more components:
i)Raw materials and (ii) work-in-progress.
An analyst may also be interested in
examining the efficiency with which the firm
converts raw materials into work-in-
process and work-in- process into finished
44
goods.
ZENITH BANK
That is, the analyst would like to know the
levels of raw materials inventory and work-
in-process held by the firm on average. The
raw material inventory should be related to
material consumed (if available), and work-
in-process to the cost of production (if
available). Thus:
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Raw material inventory turnover (RMTO)
Material consumed
Average raw material
Average raw material is given by:
38406 + 45774
2 = 42090
Thus;
275152 = 6.5 times
RMTO =
42090
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We can also determine the number of days’
raw material held (NRH).
RMTO =
Average RM Stock x 365 =
42090 x 365 = 56days
Material Consumed 75152
W- I- P Inventory turnover (WTO)
Cost of production
Average WIP Stock
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Average WIP is given by:
15055 + 23084 = 19070
2
Thus:
327152 = 17 times
19070
We can also determine the number of days WIP
held (NWH), which represents how long it takes
to convert RM into finished goods.
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NWH = Average WIP Stock x 365 = 19070 x 365 = 21 days
Cost of Production 327152
ABC’s inventories of raw material and work-

in-process on average turn respectively 6.5
times and 17 times in a year. Interpreted
differently, the company holds 56 days’
inventory of raw material and 21 days’
inventory of work-in-process.
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TABLE 05 ABC PLC
SUMMARY OF INVENTORY TURNOVER RATIO
2011 2012 2013
Finished goods turnover 12.9 11.9 8.6
Number of days finished Goods
held (days) 2.8 30 42
W-I-P turnover 27 20.5 17
No of days WIP held (days) 13 18 21
Materials turnover 6.5 6.4 6.5
Number of days RM held (days) 54 55 56
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ABC’s efficiency in turning its inventories is
continuously deteriorating. The company’s utilisation
of inventories in generating sales (revenues) is poor,
the yearly holding of all types of inventories is
increasing.
Receivables Turnover (RT)
This is computed as follows:
TR
Average Receivables
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Average receivables = 34061 + 48318
2
371723
= 9.02 times
41190
Receivables turnover indicates the number of times
receivables turnover each year. Generally, the higher
the value of receivables turnover, the more efficient
is the management of receivables.
Average collection period (ACP).
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ACP = Average Receivables X 365 or No. of days in the period
Revenue RT
41190 365
= X 365 or = 40 days
371723 9.02
A relatively high receivables turnover ratio (and

commensurately low ACP) might indicate highly
efficient credit and collection.
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Alternatively, a high receivables turnover
ratio could indicate that the company’s
credit or collection policies are too
stringent, suggesting the possibility of
sales being lost to competitors offering
more lenient terms. A relatively low
receivables turnover ratio would typically
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raise questions about the efficiency of the
company’s credit and collections proce-
dures. As with inventory management,
comparison of the company’s sales
growth relative to the industry can help
the analyst assess whether sales are
being lost due to stringent credit policies.
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TABLE 06 ABC PLC
RECEIVABLES TURNOVER
2011 2012 2013
Receivables turnover (times) 10.2 9.5 9.02
Average collection period (days) 36 38 40
These ratios indicate that the company is
increasingly becoming inefficient with the
management of its receivables.
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PAYABLES TURNOVER (PT)
This ratio measures how many times per year the
company theoretically pays off all its payables.
Purchases
PT =
Average Payables
No information on purchases is given and
therefore the ratio cannot be computed.
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Average Payment Period (APP)
Average Payables X 365 0r 365
Purchases APP
The average payment period reflects the avera-
ge number of days the company takes to pays
its suppliers.
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Payables turnover ratio that is high (low
APP) relative to the industry could indicate
that the company is not making full use of
available credit facilities, alternatively, it
could result from a company taking
advantage of early payment discounts. An
excessively low turnover ratio (high APP)
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could indicate trouble making
payments on time, or alternatively,
exploitation of lenient supplier terms.
This is another example where it is
useful to look simultaneously at other
ratios.
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If liquidity ratios indicate that the
company has sufficient cash and other
short-term assets to pay obligations
and yet the APP is relatively high, the
analyst would favour the lenient
supplier credit and collection policies
as an explanation.
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WORKING CAPITAL TURNOVER (WCT)
Working capital turnover indicates how
efficiently the company generates revenue with
its working capital. For example, a working
capital turnover ratio of 5.0 indicates that
the company generates N5 of revenue for
every N1 of working capital.
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A high working capital turnover
ratio indicates greater efficiency
(i.e. the company is generating a
high level of revenues relative to
working capital).
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The ratio is computed as follows:
WCT = TR
Average working capital
Average working capital = 28098 + 31517

2
= 29807.50
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NON - CURRENT ASSET TURNOVER (NCAT)
This ratio measures how efficiently the
company generates revenues from its
investments in non-current assets.
Generally, a higher NCAT ratio indicates
more efficient use of non-current assets
in generating revenue.
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A low ratio can indicate inefficiency, a
capital-intensive business environment, or a
new business not yet operating at full
capacity - in which case the analyst will not
be able to link the ratio directly to efficiency.
The ratio is computed as:
NCAT = TR
Average net non-current assets
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Average net non-current assets = 66362 + 74683
2
= 70,523
Thus, for ABC Plc:
371723
NCAT = = 5.3 times
70523
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TOTAL ASSET TURNOVER (TAT)
This ratio measures the company’s overall
ability to generate sales (revenues) with a
given level of assets. A ratio of 2 would
indicate that the company is generating N2
of sales for every N1 of average assets. A
higher ratio indicates greater efficiency.
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Because this ratio includes both non-
current and current assets, inefficient
working capital management can distort
overall interpretations. It is therefore,
helpful to analyse working capital and non-
current asset turnover ratio separately.
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The ratio is computed as :
TR
TAT = = 5.3 times
Average Total Assets
The average total assets can be computed as follows:
2012 2013
N N
Net non-curent assets 66362 74683
Total current assets 140453 187092
Net total asset 206815 261775
Average = 206815 + 261775 = 234,295

2
TAT = 371723 = 1.6 times
234295
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TABLE 07 ABC PLC
SUMMARY OF ACTIVITY RATIOS
2011 2012 2013
WCT (times) 12.4 12.7 12.5
NCAT (times) 4.8 4.7 5.3
TAT (times) 1.7 1.6 1.6
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LIQUIDITY RATIOS
It is extremely essential for a firm to be able to
meet its obligations as they become due.
Liquidity ratios measure the ability of the firm
to meet its current obligations (liabilities). The
most common ratios, which indicate the extent
of liquidity or lack of it are discussed below.
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CURRENT RATIO
This ratio is calculated by dividing current assets by current liabilities:
Current Ration = Current assets = 5.3 times
Current liabilities
It is a measure of the firm’s short-term solvency. It
indicates the availability of current asset in naira for
every one naira of current liability. A ratio of greater
than one means that the firm has more current
assets than current claims against them.
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For ABC Plc, the current ratio is:
N187092
Current Ration = N155575
= 1.20:1
INTERPRETATION
As a general rule, a current ratio of 2 to 1 or
more is considered satisfactory. ABC Plc has
a current ratio of 1.20:1; therefore, it may be
interpreted to be insufficiently liquid.
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The current ratio represents a margin
of safety for short-term creditors. The
higher the current ratio, the greater the
margin of safety; the larger the amount
current assets in relation to current
liabilities, the more the firm’s ability to
meet its current obligations.
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It should be noted however, that an
arbitrary standard of 2 to 1 should not be
blindly followed. Firms with less than 2 to 1
current ratio may be doing well, while firms
with 2 to 1 or even higher current ratio may
be struggling to meet their obligations. This
is so because current ratio is a test of
quantity, not quality.
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The ratio measures only total naira worth
of current assets and total naira worth of
current liabilities. It does not measure the
quality of assets. Liabilities are not subject
to any fall in value; they have to be paid in
full. But current assets can decline in
value. If the firm’s current assets consist
of doubtful and slow moving debtors or
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slow moving and obsolete stock of goods,
then the firm’s ability to pay bills is
impaired; its short-term solvency is
threatened. Thus, too much reliance
should not be placed on the current ratio; a
further investigation about the quality of
the items of current assets is necessary.
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QUICK RATIO
Quick ratio, also called acid-test ratio,
establishes a relationship between quick,
or liquid, assets and current liabilities. An
asset is liquid if it can be converted into
cash immediately or reasonably soon
without a loss of value.
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Like the current ratio, a higher quick ratio
indicates greater liquidity, other factors
remaining the same. The quick ratio is
found out by dividing quick assets by
current liabilities.
Current Ratio = Current assets - Inventories
Current liabilities
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For ABC Plc, the ratio is:
N72053 = 0.46:1
N155575
Thus, if the company’s inventories do not
sell, and it has to pay all its current
liabilities, it may find it difficult to meet its
obligations because its quick assets are
46% of current liabilities.
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Generally, a quick ratio of 1 to 1 is
considered to represent a satisfactory
current financial condition. Although quick
ratio is a more penetrating test of liquidity
than current ratio, yet it should be used
cautiously. A quick ratio of 1 to 1 or more
does not necessarily imply sound liquidity
position.
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It should be remembered that all
receivables may not be liquid, and cash
may be immediately needed to pay
operating expenses. Thus, a company with
a high value of quick ratio can suffer from
shortage of funds if it has slow paying,
doubtful and long-duration outstanding
receivables.
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On the other hand, a company with a low
value of quick ratio may really be
prospering and paying its current
obligation in time if it has been turning
over its inventories efficiently.
Nevertheless, the quick ratio remains an
important index of the firm’s liquidity.
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SOLVENCY RATIOS
Solvency refers to a company’s ability to
fulfill its long-term debt obligations.
Assessment of a company’s ability to pay
its long-term obligations (i.e. to make
interest and principal payments) generally
includes an in-depth analysis of the
components of its financial structure.
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Solvency ratios provide information regarding
the relative amount of debt in the company’s
capital structure and the adequacy of
earnings and cash flow to cover interest
expenses and other fixed changes (such as
lease or rental payments) as they come due.
Analysts seek to understand a company’s use
of debt for several main reasons.
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One reason is that the amount of debt in a
company’s capital structure is important
for assessing the company’s risk and
return characteristics, specifically its
financing leverage. Leverage is a
maginifying effect that results from the
use of fixed costs-costs that stay the same
within some range of activity.
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When financing a firm (i.e. raising capital
for it), the use of debt constitutes financial
leverage because interest payments are
essentially fixed financing costs. As a
result of interest payments, a given
percentage change in EBIT results in a
larger percentage change in profit before
tax (PBT)
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Thus, financial leverage tends to
magnify the effect of changes in EBIT
on returns flowing to shareholders.
A company’s relative solvency is
fundamental to valuation of its debt
securities and its creditworthiness.
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Finally, understanding a company’s use
of debt can provide analysts with
insight into the company’s future
business prospects because manage-
ments decisions about financing often
signal their beliefs about a company’s
future.
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CALCULATION OF SOLVENCY RATIOS
Solvency ratios are primarily of two
types. Debt ratios, the first types,
focus on the SFP and measure the
amount of debt capital relative to
equity capital.
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Coverage ratios, the second type,
focus on the income statement and
measure the ability of a company to
cover its debt payments. All of these
ratios are useful in assessing a
company’s solvency.
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DEBT RATIOS
Several debt ratios may be used to analyse
the long-term solvency of a firm. Three of
these ratios are detailed below.
i)Debt-to-Asset Ratio
This ratio measures the percentage of total
assets financed with debt. For example, a
debt- to- assets ratio of 0.40 or
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40% indicates that 40% of the company’s
assets are financed with debt. Generally,
higher debt means higher financial risk
and thus weaker solvency.
Debt -to- asset ratio is calculated using
the following formula:
Total Debt
Total Assets
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For ABC Plc, the calculations are set out below:
2011 2012 2013
N000 N000 N000
Debt Long-term debt 19,987 36165 38,919
Short-term bank borrowings 44,292 64,139 83,987
Total Debt... ... (k) 64,279 100,304 122,906
Total Assets
Fixed Assets 54,670 66,362 74,683
Current assets 86,608 140,455 187,092
Total assets ....(P) 141,278 206,817 261,775
Debt-to- assets ratio (K÷ P) 45%
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48% 47%
95
ii) DEBT-TO-CAPITAL RATIO

The debt-to-capital ratio measures the
percentage of a company’s capital (debt plus
equity) represented by debt. As with the
previous ratio, a higher ratio generally means
higher financial risk and thus indicates weaker
solvency.
Debt-to-Capital Ratio is computed as = Total Debt
Total Debt + Shareholders Fund
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For ABC Plc, the ratio is computed as detailed below:
2011 2012 2013
N000 N000 N000
Debt
Total debt as above (k) 64,279 100,304 122,906
Shareholders funds (P) 51,113 58,295 67,281
Total (k +P) = TC = 115,392 158,599 190,187
Debt-to-capital ratio = K ÷ TC 58% 63% 65%
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iii)DEBT-TO-EQUITY RATIO
The debt-to-equity ratio measures the
amount of debt capital relative to equity
capital. Interpretation is similar to the
preceding two ratios (i.e., a higher ratio
indicates weaker solvency).
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A ratio of 1.0 would indicate equal amounts of

debt and equity, which is equivalent to a
debt-to-capital ratio of 50 percent.
Alternative definitions of this ratio use the
market value of shareholders’ equity rather
than its book value (or use the market values
of both shareholders’ equity and debt).
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The ratio is computed using the following formula:

Total Debt
Debt-to-capital Ratio is computed as
Shareholders’ Funds
iv) FINANCIAL LEVERAGE RATIO

This ratio (often simply called the “leverage
ratio”) measures the amount of total assets
supported for each one money unit of equity.
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For example, a value of 3 for this ratio means that each
N1 of equity supports N3 of total assets. The higher the
financial leverage ratio, the more leveraged the
company is in the sense of using debt and other
liabilities to finance assets. This ratio is often defined in
terms of average total assets and average total equity.
Financial leverage is computed using the following
formula:
Average Total Assets (ATA)
Debt-to-Equip Ratio =
Average Total Equity (ATE)
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For ABC Plc:

2011 2012
N000 N000
Total Assets:
- at the beginning 141,278 206,817
- at the end 206,817 261,775
348,095 468,592
Average (÷ 2) = ATA 174,048 34,296
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Total equity at the

- at the beginning 51,113 58,295
- at the end 58,295 67,281
109,408 125,576
Average ( ÷2) = ATE 54,704 62,788
Financial Leverage Ratio

= ATA ÷ ATE 3.2 3.7
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ABLE: 08 ABC PLC
Summary of Debt Ratios
2011 2012 2013
N000 N000 N000
 Debt- to -assets ratio (%) 45 48 47
 Debt- to - capital ratio (%) 58 63 65
 Debt - to equity ratio (%) 126 172 183
 Financial leverage ratio 2.9 3.2 3.7
The various debt ratios have increased over the years.
From lenders’ point of view, the trend is risky and
undersirable.
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COVERAGE RATIOS
Debt ratios described above are static in
nature, and fail to indicate the firm’s
ability to meet interest (and other fixed
charges) obligations. The following
coverage ratios could assist in this
regard.
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INTEREST COVERAGE
This ratio measures the number of times a
company’s EBIT could cover its interest
payments. A higher interest coverage ratio
indicates stronger solvency, offering greater
assurance that the company can service its
debt (i.e., bank debt, bonds, notes) from
operating earnings.
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It is computed as follows:
Interest Coverage =
EBIT
Interest
For ABC Plc, the ratio is computed as detailed below:
2011 2012 2013
N000 N000 N000
EBIT 18,538 26,617 34,261
Interest 5,984 12,498 14,346
Interest Cover (times) 3.10 2.13 2.39
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The interest coverage ratio has gone down over

the years signifying increasing use of debt and
deteriorating solvency.
FIXED CHARGE COVERAGE
This ratio relates fixed charges, or obligations,
to the cash flow generated by the company. It
measures the number of times a company’s
earnings
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(before interest, taxes, and lease payments)

can cover the company’s interest and lease
payments. Similar to the interest coverage
ratio, a higher fixed charge coverage ratio
implies stronger solvency, offering greater
assurance that the company can service its
debt (i.e., bank debt, bonds, notes, and leases)
from normal earnings.
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The ratio is sometimes used as an indication of

the quality of the preference dividend, with a
higher ratio indicating a more secure
preference dividend.
Fixed charge coverage is computed as: EBIT + Lease Payments
Interest Payments + Lease Payments
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CLASS REFRESHMENT
Evaluation of Solvency Ratios
A credit analyst is evaluating the solvency of XYZ Plc.
The following data are gathered from the company’s
2012 annual report (in N millions):
2012 2011
N000 N000
Total equity 4,389 4,038
Accrued pension 1,144 1,010
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Other reserves 2,278 3,049

Total financial debt 4,359 5,293
Other liabilities 6,867 7,742
Total assets 19,037 21,132
The analyst concludes that, as used by XYZ in its
2012 annual report, “total financial debt”
consists of long-term debt and the interest-
bearing, borrowed portion of current liabilities.
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1. A. Calculate the company’s financial leverage

ratio for 2012.
B. Interpret the financial leverage ratio calculated
in Part A.
2. A. What are the company’s debt-to assets, debt-
to - capital, and debt- to -equity ratios for the
two years?
B. Is there any discernable trend over the two
years?
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PROFITABILITY RATIOS
The ability to generate profit on capital
invested is a key determinant of a
company’s overall value of the securities it
issues. Consequently, many analysts would
consider profitability to be a key focus of
their analytical efforts.
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Profitability reflects a company’s competitive

position in the market, and by extension, the quality
of its management. The income statement reveals
the sources of earnings and the components of
revenue and expenses. Earnings can be distributed
to shareholders or reinvested in the company.
Reinvested earnings enhance solvency and provide
a cushion against short-term problems.
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CALCULATION OF PROFITABILITY RATIOS

Profitability ratios measure the return
earned by the company during a period.
Table 9 provides the definitions of a
selection of commonly used profitability
ratios.
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ABLE 09: DEFINITIONS OF COMMONLY USED

PROFITABILITY RATIOS
Profitability Ratios Numerator Denominator
Return on Sales
Gross profit margin Gross profit Revenue
Operating Operating income Revenue
Profit margin
Pretax margin EBT (earnings before tax Revenue
but after interest)
Net profit margin Net income Revenue
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Return on Investment
Operating ROA Operating income Average total assets
ROA Net income Average total assets
Return on total capital EBIT Short-and long-term
debt and equity
ROE Net income Average total equity
Return-on-sales profitability ratios express various

subtotals on the income statement (e.g., gross
profit, operating profit, net profit) as a percentage of
revenue.
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Return on investment profitability ratios measure income relative
to assets, equity, or total capital employed by the company. For
operating ROA, returns are measured as operating income, i.e.,
prior to deducting interest on debt capital. For ROA and ROE,
returns are measured as net income, i.e., after deducting interest
paid on debt capital.
i) GROSS PROFIT MARGIN (GPM)
Gross profit margin indicates the percentage of revenue
available to cover operating and other expenditures. Higher
gross profit margin indicates some combination of higher
product pricing and lower product costs.
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The ability to charge a higher price is constrained
by competition, so gross profits are affected by
(and usually inversely related to) competition. If a
product has a competitive advantage (e.g.,
superior branding, better quality, or exclusive
technology), the company is better able to charge
more for it. On the cost side, higher gross profit
margin can also indicate that a company has a
competitive advantage in product costs.
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For ABC Plc, the GPM can be computed as follows.
%
40,986
2011 x 100 = 17.5
233,890
50,289
2012 x 100 = 17,8
282,569
2013 66,357 x 100 = 17,9
371,723
The GPM remained virtually constant over the three-year
period.
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ii) OPERATING PROFIT MARGIN (OPM)

Operating profit is calculated as gross margin minus
operating costs. If there are no dividend incomes and
gains/losses on investment securities, operating income
will be taken as EBIT. An operating margin increasing
faster than the gross profit margin can indicate
improvements in controlling operating costs, such as
administrative overheads. In contrast, a declining
operating profit margin could be an indicator of
deteriorating control over operating costs.
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For ABC Plc, the OPM are detailed below:
%
2011 17,014 x 100 = 7.3
233,890
24,079
2012 x 100 = 8.8
282,569
30,570
2012 x 100 = 8.2
371,723
There appears to be a good control over operating costs as the
OPM has increased over the period, although it dropped marginally
in 2013.
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iii) PRETAX MARGIN

Pretax income (also called “Profit before tax”) is calculated
as operating profit minus interest, so this ratio reflects the
effects on profitability of leverage and other (non-
operating) income and expenses. If a company’s pretax
margin is rising primarily as a result of increasing non-
operating income, the analyst should evaluate whether this
increase reflects a deliberate change in a company’s
business focus and, therefore, the likelihood that the
increase will continue.
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For ABC Plc, the Pretax Margin is computed below:

%
12,554
2011 x 100 = 5.4
233,890
2012 14,119 x 100 = 5.0

282,569
19,915
2012 x 100 = 5.4
371,723
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iv) NET PROFIT MARGIN

Net Profit is obtained when operating expenses, interest
and taxes are subtracted from gross profit. The net profit
margin ratio is measured by dividing profit after tax by
sales:
Net Profit is obtained when operating expenses, interest
and taxes are subtracted from gross profit. The net profit
margin ratio is measured by dividing profit after tax by
sales:
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Profit After tax
Net Profit Margin =
Sales
%
2011 8,375 x 100 = 3.6
233,890
11,119
2012 x 100 = 3.9
282,569
2012 13,486 x 100 = 3.6
371,723
Like the preceding ratio, this ratio have remained more or less
constant, 2012 probably being an unusual year.
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If the non-operating income figure is substantial, it

may be excluded from PAT to see profitability
arising directly from sales. For ABC Plc, operating
profit after taxes to sales ratio is 3.6 per cent.
Net profit margin ratio establishes a relationship
between net profit and sales and indicates
management’s efficiency in manufacturing,
administering and selling the products.
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This ratio is the overall measure of the firm’s ability to turn

each naira sales into net profit. If the net margin is
inadequate, the firm will fail to achieve satisfactory return
on shareholders’ funds.
This ratio also indicates the firm’s capacity to withstand
adverse economic conditions. A firm with a high net margin
ratio would be in an advantageous position to survive in the
face of falling selling prices, rising costs of production or
declining demand for the product. It
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would really be difficult for a low net margin

firm to withstand these adversities. Similarly, a
firm with high net profit margin can make better
use of favourable conditions, such as rising
selling prices, falling costs of production or
increasing demand for the product. Such a firm
will be able to accelerate its profits at a faster
rate than a firm with a low net profit margin.
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v) ROA
ROA measures the return earned by a company on its
assets. The higher the ratio, the more income is
generated by a given level of assets. Most analysts
compute this ratio as:
Net income
Average total assets ………………………….. (A)
The problem with this computation is net income is the
return to equity holders, whereas assets are financed by
both equity holders and
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creditors. Interest expense (the return to payables) has already
been subtracted in the numerator. Some analysts, therefore,
prefer to add back interest expense in the numerator. In such
cases, interest must be adjusted for income taxes because net
income is determined after taxes. With this adjustment, the ratio
would be computed as:
Net Income + Interest Expense (1 - Tax rate)
Average total assets …………….. (B)
Alternatively, some analysts elect to compute ROA on a pre-interest and
pretax basis as:
Operating Income EBIT
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Average total assets
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………………………………………………… (C)
As noted, returns are measured prior to deducting interest on debt
capital (i.e., as operating income or EBIT). This measure reflects the
return on all assets invested in the company, whether financed with
liabilities, debt, or equity. Whichever form of ROA that is chosen, the
analyst must use it consistently in comparisons to other companies or
time periods.
We demonstrate below, how the three versions can be computed.
Net Income
A. ROA =
%
11,119
2012 x 100 = 6.4
174,048
2012 13,486 x 100 = 5.8
234,296
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Net Income + Interest ( 1- Tax Rate)
B. ROA =
Since we do not have information on the tax rate used, we modify the
formula to become:
Net Income + Interest
ROA =
%
2012 11,119 + 12,498 x 100 = 13.6
174,048
2013 13,486 + 14,346 x 100 = 11.9

234,296
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EBIT
C. ROA =
%
26,617
2012 x 100 = 13.6
174,048
2013 34,261 x 100 = 11.9

234,296
All the three versions show a decline in ROA over the years
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vi) RETURN ON EQUITY (ROE)

ROE measures the return earned by a company on its equity
capital. It is computed as follows:
Net Income
D. ROA =
Average Equity
11,119
2012 x 100 = 13.6%
54,704
13,486
2013 x 100 = 11.9%
62,788
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ROE indicates how well the firm has used the

resources of owners. In fact, this ratio is one of
the most important relationships in financial
analysis. The earning of a satisfactory return is
the most desirable objective of a business. The
ratio of net profit to owners’ equity reflects the
extent to which this objective has been
accomplished.
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This ratio is, thus, of great interest to the present
as well as the prospective shareholders and also of
great concern to management, which has the
responsibility of maximising the owners’ welfare.
The returns on owners’ equity of the company should
be compared with the ratios for other similar
companies and the industry average. This will reveal
the relative performance and strength of the
company in attracting future investments.
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DUPONT ANALYSIS: THE DECOMPOSITION OF ROE

As noted earlier, ROE measures the return a
company generates on its equity capital. To
understand what drives a company’s ROE, a useful
technique is to decompose ROE into its component
parts. (Decomposition of ROE is sometimes referred
to as DuPont analysis because it was developed
originally at that company.)
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Decomposing ROE involves expressing the basic ratio

(i.e., net income divided by average shareholders’
equity) as the product of component ratios. Because
each of these component ratios is an indicator of a
distinct aspect of a company’s performance that
affects ROE, the decomposition allows us to evaluate
how these different aspects of performance affect
the company’s profitability as measured by ROE.
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Decomposing ROE is useful in determining the

reasons for changes in ROE over time for a given
company and for differences in ROE for different
companies in a given time period. The information
gained can also be used by management to
determine which areas they should focus on to
improve ROE. This decomposition will also show why
a company’s overall profitability, measured by ROE,
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is a function of its efficiency, operating

profitability, taxes, and use of financial
leverage. DuPont analysis shows the
relationship between the various categories
of ratios discussed in this paper and how
they all influence the return to the
investment of the owners.
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Analysts have developed several different methods of decomposing ROE.

The decomposition presented here is one of the most commonly used .
Return on equity is calculated as:
ROE = Net income / Average shareholders’ equity
The decomposition of ROE makes use of simple algebra and illustrates the
relationship between ROE and ROA. Expressing ROE as a product of only
two of its components, we can write:
ROA = Net Income

Average shareholders’ equity
Net Income Average Total Assets
ROE = X
Average Total Assets Average Shareholders’ Equity
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Which can be interpreted as:
143
ROE = ROA x Leverage
In other words, ROE is a function of a company’s ROA

and its use of financial leverage (“leverage” for
short, in this discussion). A company can improve its
ROE by improving ROA or making more effective use
of leverage. Consistent with the definition given
earlier, leverage is measured as average total
assets divided by average shareholdedrs’ equity. If a
company had no leverage (no liabilities), its leverage
ratio would equal 1.0 and ROE would exactly equal
ROA.
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As a company takes on liabilities, its leverage

increases. As long as a company is able to borrow at
a rate lower than the marginal rate it can earn
investing the borrowed money in its business, the
company is making an effective use of leverage and
ROE would increase as leverage increases. If a
company’s borrowing cost exceeds the marginal
rate it can earn on investing, ROE would decline as
leverage increased because the effect of borrowing
would be to depress ROA.
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Using data from ABC Plc, an analyst can examine the trend in ROE
and determine whether the change in ROE is a function of ROA or
the use of leverage:
ROE = ROA x Leverage
2012 20.3 = 6.4 x 3.2
2013 21.5 = 5.8 x 3.7
The primary reason for the increase in ROE in 2013 is the
increase in leverage rather than increase in profitability. A
company that consistently generates increase in ROE from
increase in leverage rather than from increase in ROA
(Profitability) is not a good candidate for lending.
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Just as ROE can be decomposed, the individual components such

as ROA can be decomposed. Further decomposing ROA, we can
express ROE as a product of three component ratios:
Net Income Net Income Revenue

= x
Average Shareholders’ Equity Revenue Average Total Assets

x
Average Shareholders’ Equity
 Which can be interpreted as:
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ROE = Net Profit Margin (NPM) x Asset Turnover (ATO) x

Leverage (L).
The first term on the right-hand side of this equation is
the net profit margin, an indicator of profitability: how
much income a company derives per naira of sales. The
second term on the right is the asset turnover ratio, an
indicator of efficiency: how much revenue a company
generates per naira of assets. Note that ROA is
decomposed into these two components: net profit margin
and asset turnover.
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For ABC Plc, the decomposition is as detailed below:

ROE = NPM x ATO x L
2012 20.3 = 3.94 x 1.62 x 3.18
2013 21.5 = 3.63 x 1.59 x 3.73
This decomposition of ROE has therefore shown that in
2013:
• Profitability has declined
• Efficiency in the use of the company’s assets to
generate sales has deminished, but
• Financial leverage has increased.
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LIMITATIONS OF FINANCIAL RATIOS

There are several limitations of analyzing a company
using financial ratios.
* Financial ratios are not useful when viewed in
isolation. They are only valid when compared to
other firms or the company’s historical performance.
* Comparisons with other companies are made more
difficult because of different accounting treatments.
This is particularly important when analyzing foreign
owned companies.
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150
* It is difficult to find comparable industry ratios

when analyzing companies that operate in
multiple industries.
* Conclusions cannot be made from viewing one set
of ratios. All ratios must be viewed relative to one
another.
* Determining the appropriate target or comparison
value for a ratio is difficult. There might be cases
in which the industry average is not the optimal
target to which a firm should be compared.
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151
Loan Deposit Ratio (LDR)
The loan deposit ratio (LDR) is used to assess a bank's liquidity by
comparing a bank's total loans to its total deposits for the same period.
The LDR is expressed as a percentage. If the ratio is too high, it means
that the bank may not have enough liquidity to cover any unforeseen
fund requirements. Conversely, if the ratio is too low, the bank may not
be earning as much as it could be.
Generally, it is calculated as follows:
Total Loans
LDR =
Total Deposits
152 ZENITH BANK

To calculate the loan deposit ratio, divide a bank's total amount of loans
by the total amount of deposits for the same period. You can find the
figures on a bank's statement of financial position. Loans are listed as
assets while deposits are listed as liabilities.
What Does LDR Tell You?

A loan deposit ratio shows a bank's ability to cover loan losses and
withdrawals by its customers. Investors monitor the LDR of banks to
make sure there's adequate liquidity to cover loans in the event of an
economic downturn resulting in loan defaults.
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Also, the LDR helps to show how well a bank is attracting and retaining
customers. If a bank's deposits are increasing, new money and new
clients are being on-boarded. As a result, the bank will likely have more
money to lend, which should increase earnings. Although it's
counterintuitive, loans are an asset for a bank since banks earn
interest income from lending. Deposits, on the other hand, are liabilities
because banks must pay an interest rate on those deposits, albeit at a
low rate.
The LDR can help investors determine if a bank is managed properly. If

the bank isn't increasing its deposits or its deposits are shrinking, the
bank will have less money to lend. In some cases, banks will borrow
154 ZENITH BANK
money to satisfy its loan demand in an attempt to boost interest
income. However, if a bank is using debt to finance its lending
operations instead of deposits, the bank will have debt servicing costs
since it will need to pay interest on the debt.
As a result, a bank that borrows money to lend to its customers will

typically have lower profit margins and more debt. A bank would rather
use deposits to lend since the interest rates paid to depositors are far
lower than the rates it would be charged for borrowing money. The LDR
helps investors spot the banks that have enough deposits on hand to
lend and won't need to resort to increasing their debt.
155 ZENITH BANK

The proper LDR is a delicate balance for banks. If banks lend too much
of their deposits, they might overextend themselves, particularly in an
economic downturn. However, if banks lend too few of their deposits,
they might have opportunity cost since their deposits would be sitting
on their statement of financial positions earning no revenue. Banks with
low LTD ratios might have lower interest income resulting in lower
earnings.
156 ZENITH BANK

Key Takeaways
• The loan deposit ratio is used to assess a bank's liquidity by
comparing a bank's total loans to its total deposits for the same
period.
• To calculate the loan deposit ratio, divide a bank's total amount of
loans by the total amount of deposits for the same period.
• Typically, the ideal loan deposit ratio is 80% to 90%. A loan
deposit ratio of 100 percent means a bank loaned one naira to
customers for every naira received in deposits it received.
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Example
If a bank has ₦500 million in deposits and ₦400 million in loans, the
bank's LDR ratio would be calculated by dividing the total loans by its
total deposits.
₦400 million
LDR = = 0.8 = 80%
₦500 million
158 ZENITH BANK

Limitations of the LDR
The LDR helps investors to assess the health of a bank's statement of
financial position, but there are limitations to the ratio. The LDR does
not measure the quality of the loans that a bank has issued. The LDR
also does not reflect the number of loans that are in default or might be
delinquent in their payments.
As with all financial ratios, the LDR is most effective when compared to
banks of the same size, and similar makeup. Also, it's important for
investors to compare multiple financial metrics when comparing banks
and making investment decisions.
159 ZENITH BANK

CBN and LDR
In order to ramp up (stimulate) growth of the Nigerian economy
through investment in the real sector, the CBN in July 2019 imposed a
LDR of 60% on all Deposit Money Banks (DMBs) in Nigeria.
In September 2019, the ratio was increased to 65%.
In order to encourage SMEs, Retail, Mortgage and Consumer Lending,
these sectors are assigned a weight of 150% in computing the LDR.
Failure to meet the above minimum LDR by the specified date shall
result in a levy of additional Cash Reserve Requirement equal to 50% of
the lending shortfall of the target LDR.
160 ZENITH BANK
Example
Assume the following facts were extracted from the books of a bank.
₦m
Loans to:
- SMEs, etc 100
- Other sectors 300
Total deposit 900
a) According to the current CBN policy, what is the bank’s LDR?
b) Do you think CBN will impose additional cash Reserve Requirement?
Justify your answer.
161 ZENITH BANK
Possible problems with the CBN Directive
• Possible significant increase in banks’ non-performing loans
• Possible drop in banks’ income
• Possible price war among banks as they compete for good corporate
names to boost their loan portfolio.
162 ZENITH BANK

2017
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2017
PPE & DEPRECIATION
ADEMOLA OMOLEHINWA & CO
Introduction
For simplicity purpose, Property, Plant and Equipment (PPE) are
resources of material value controlled or owned by the business, not
primarily for resale, with useful life extending beyond one accounting
year (12 months). Examples of PPE are land, building, plant, machinery,
etc. With the exception of land, Property, plant and equipment have a
finite useful life. They will eventually wear out because of physical
deterioration, technological changes.
When a business acquires an asset to be used for more than one

accounting year, it is necessary to spread the cost of that asset over
its estimated useful life.
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While buildings, plant and equipment are depreciated, natural
resources are depleted, patents and leaseholds and other intangible
assets are amortised over their useful lives.
Definition of Related Terms
1. Cost: This is the amount of cash or cash equivalents paid or the
fair value of the other consideration given to acquire an asset at
the time of its acquisition or construction.
It is the actual amount paid plus all incidental costs e.g. delivery
costs, installation cost, legal charges and other directly
attributable costs incurred in bringing the asset to its location and
a proper working condition.
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3
2. Depreciation: This is the systematic allocation of the depreciable
amount of an asset over its estimated useful life. This can also be
referred to as the portion of asset’s value (depreciable amount)
that relates to an accounting year.
3. Accumulated Depreciation: This is the total depreciation charged
to date on property, plant and equipment from the time it was
bought.
4. Carrying amount (or Net Book Value): The carrying amount or
net book value of PPE as at a particular date is equal to its cost
less the accumulated depreciation to date.
4 ZENITH BANK
It represents the portion of the cost of an asset that is yet to be
written off. It is the carrying amount of the PPE that will be shown
or recognized in the statement of financial position.
5. Residual value (or scrap value): This is the net amount which the
entity expects to realize from an asset at the end of its useful life
after deducting the expected costs of disposal.
6. Useful life: This is the period over which a depreciable asset is
expected to be used by the entity. It can also be referred to as the
number of production or similar units expected to be obtained
from the asset by the entity.
5 ZENITH BANK
7. Revaluation surplus: This is the excess of the revalued amount of
an asset over its carrying amount (net book value).
8. Revaluation deficit: This is the excess of the carrying amount (net
book value) of an asset over its revalued amount.
Non-Current Assets; Property, Plant & Equipment and

Depreciable Value
Non-Current Assets
For us to understand the term “Non-current Assets”, we need to
understand the term “Current Assets” first.
6 ZENITH BANK
Current Assets
Assets are classified as current when any or a combination of the
following conditions is met.
1. The asset is held primarily for the purpose of trading.
2. It is expected to realise the asset within 12 months after the
reporting period.
3. The asset is cash or a cash equivalent.
7 ZENITH BANK
Non-Current Assets
According to IAS 1 “Presentation of financial statements”, all assets
that are non current assets are classified as non-current assets.
However, it is expected that all non-current assets will have a life
span of more than 12 months.
Property, Plant and Equipment

These are tangible assets that are held for use in the production or
supply of goods or services. It also includes assets held for rental or
for administrative purposes. They are expected to be used during
more than one accounting period.
8 ZENITH BANK
Depreciable Value (or depreciable amount)
This is the cost value (or revalued amount) of an asset less its
residual or scrap value.
Example 1
The following are extracted from the books of Aba Bank Ltd as at 31
December, 2019
9 ZENITH BANK
₦
Land 10,000
Buildings 20,000
Machinery 12,000
Furniture and fittings 6,000
Motor vehicles 9,000
Inventories 11,000
Intangible assets 15,000
10 ZENITH BANK
The estimated residual or scrap value of the assets are as follows:
₦
Building 3,000
Machinery 2,000
Required: Determine the following:

a. The non-current assets value of Aba Bank Ltd
b. The property, plant and equipment value of Aba Bank Ltd
c. The depreciable amount of property, plant and equipment of Aba
Bank Ltd
11 ZENITH BANK
Solution
a. Calculation of non-current assets of Aba Bank Ltd
₦
Land 10,000
Buildings 20,000
Machinery 12,000
Intangible assets 15,000
Non-current asset value 72,000
12 ZENITH BANK
b. Calculation of property, plant and equipment of Aba Bank Ltd
₦
Land 10,000
Buildings 20,000
Machinery 12,000
Non-current asset value 57,000
13 ZENITH BANK
c. Calculation of depreciable amount of Aba Bank Ltd
Cost value Residual value Depreciable amount
A B C=A-B
₦ ₦ ₦
Buildings 20,000 3,000 17,000
Machinery 12,000 2,000 10,000
Furniture and fittings 6,000 - 6,000
Motor vehicles 9,000 1,000 8,000
47,000 6,000 41,000
14 ZENITH BANK
Notes:
The depreciable amount or depreciable value = ₦41,000
Characteristics of Property, plant and equipment
In summary, a depreciable asset therefore possesses the following
characteristics:
 Longer life span (i.e. useful life of over one year)
 Must be tangible assets
 Acquired primarily for use in production of goods and services or
for administrative purpose
 Definite useful life (excluding land)
 Not intended for resale in the ordinary course of the business
15 ZENITH BANK
Cost of Property, Plant and Equipment
This is the amount of cash or cash equivalents paid or the fair value
of the other consideration given to acquire an asset at the time of its
acquisition or construction.
Components of cost
The standard lists the components of the cost of an item of property,
plant and equipment.
• Purchase price, less any trade discount or rebate
• Import duties and non-refundable purchase taxes should be added
• Directly attributable costs of bringing the asset to working
condition for its intended use should be added, such as:
16 ZENITH BANK
 The cost of site preparation
 Initial delivery and handling costs
 Installation costs
 Testing (i.e. those cost incurred to test whether the asset is
functioning properly).
 Professional fees (architects, engineers)
17 ZENITH BANK
Example 2
PQ, a business centre, purchased a computer for use in his business.
The invoice for the computer:
₦’m
Computer 950
Additional memory 150
Delivery 20
Installation 40
Maintenance (1 year) 35
Insurance premium 15
18 ZENITH BANK
Required:
How much should be capitalised as non-current asset by PQ
Solution
Calculation of capitalized cost of the computer
₦’m
Computer 950
Additional memory 150
Delivery 20
Installation 40
ZENITH BANK
1,160
19
NB: The insurance premium and maintenance costs will be
recognised in the profit or loss.
Review of Useful Life

The following factors should be considered when estimating the
useful life of a depreciable asset.
 Expected physical wear and tear
 Obsolescence
 Legal or other limits on the use of the assets
20 ZENITH BANK
Determination of Depreciation Charge
The determination of depreciation charge on an asset for a period
depends on:
1. The cost of the asset
2. Its estimated useful life, which is determined the management
based on the following:
• The expected rate of physical wear and tear due to usage
• Obsolescence due to changes in technology, production
requirements or consumer taste
3. The estimated residual or scrap value of the asset if any
21 ZENITH BANK
Depreciation Methods
Generally, the methods of depreciating an asset can be broadly
categorised into two as follows:
1. Time-based methods 2. Usage -based methods
* Straight line method * Service-hour method
* Reducing balance method * Productive output method
* Sum-of-the digits method
* Annuity method
* Sinking fund method
22 ZENITH BANK
In this course, our discussions of the different methods will be limited
to the Straight line and the Reducing balance methods, as they are
the most commonly used in practice.
Straight Line Method

Under this method, the cost of the depreciable assess less its
residual value if any is spread in equal instalments over its estimated
useful life. The alternative name for this method is Fixed Instalment
Method
Cost − Residual Value
Annual Depreciation =
Estimated useful life
23 ZENITH BANK
Example 3: If a machine costs ₦20,000 and its useful life is
estimated to be 10 years with a residual value of ₦2,000, what is its
annual depreciation charge using the straight-line method?
Depreciation charge per annum will be:
20,000 − 2,000
= 𝟏, 𝟖𝟎𝟎. 𝟎𝟎
10 yrs
The major advantage of this method is its simplicity, while its major
disadvantage is that it charges equal amount as annual depreciation
whereas the related contribution of the asset to income may not be
equal.
24 ZENITH BANK
Reducing Balance Method
Under this method, the annual depreciation is based on a fixed
percentage of the carrying amount or net book value of the asset at
the beginning of the year. Since a fixed rate is charged on a carrying
amount or net book value that falls every year, the annual
depreciation charge reduces progressively every year. The
alternative name for this method is diminishing balance method.
The depreciation rate is calculated using the formula:
n S 100
r= 1− ×
C 1
25 ZENITH BANK
Where:
r = depreciation rate in %
n = number of years of expected useful life
s = residual value/scrap value
c = cost of the asset
Example 4:
If a Motor vehicle cost ₦100,000 and its estimated useful life is 5yrs
with residual value of ₦20,000. What is the annual depreciation
charge using reducing balance method?
26 ZENITH BANK
Solution
Rate of depreciation is determined through the use of above formula:
5 20,000 100
𝑟 = 1− × = 27.52%
100,000 1
27 ZENITH BANK
Calculation of Depreciation charge
28 ZENITH BANK
Accounting Entries
a) On purchase of PPE:
Debit: PPE Account
with the cost of the asset
Credit: Bank/Cash Payables Account.
b) At period end:
Debit: Depreciation expense
with the depreciation charge for the year
Credit: Accumulated depreciation
Note: PPE and accumulated depreciation must be maintained in their

different categories e.g. motor vehicles, furniture & fittings, equipment
etc.
29 ZENITH BANK
Example 5: Using illustration under straight line method.
Required: Open necessary accounts
Solution:
Machine Account
1/1 /Yr 1 Bank 20,000 31/12/Yr 1 Balance c/d 20,000
1/1/Yr 2 Balance b/d 20,000 31/12/Yr 2 Balance c/d 20,000
1/1/Yr 3 Balance b/d 20,000 31/12/Yr 3 Balance c/d 20,000
1/1/Yr 4 Balance b/d 20,000
30 ZENITH BANK
Depreciation Expense Account
31/12/Yr l Acc. Depr 1,800 31/12/Yr 1 P&L 1,800
31/12/Yr 2 Acc. Depr 1,800 31/12/Yr 2 P&L 1,800
31/12/Yr 3 Acc. Depr 1,800 31/12/Yr 3 P&L 1,800
31 ZENITH BANK
Accumulated Depreciation Account
31/12/Yr 1 Balance c/d 1,800 31/12/Yr 1 Depr Exp. 1,800
1/1/Yr 2 Bal b/d 1,800
31/12/Yr 2 Bal c/d 3,600 31/12/Yr 2 Depr Exp 1,800
3,600 3,600
1/1/Yr 3 Bal b/d 3,600
31/12/Yr 3 Bal b/d 5,400 31/12/Yr 3 Depr Exp 1,800
5,400 5,400
1/1/Yr 4 Bal b/d 5,400
32 ZENITH BANK
Reducing Balance Method of Depreciation and Compound Interest
Formula
The compound interest formula is very useful to deal with most of the
n
calculations under the reducing balance method. Recall that: A = P(1 + r) .
When applied to depreciation, the variables can be defined as: A = NBV, i.e.
the carrying amount.
P = initial cost of the asset
r = depreciation rate, which comes into this formula as a negative value
n = number of years.
…33 ZENITH BANK

We can use this formula to compute the closing balance (NBV) for each of
the years in the previous example:
1
Year 1 NBV = 100,000 (1 – 0.2752) = 72,480
2
Year 2 NBV = 100,000 (1 – 0.2752) = 52,533.50
3
Year 3 NBV = 100,000 (1 – 0.2752) = 38,076.28 etc.
Calculating Profit/Loss on Disposal of Asset

When a non-current asset is disposed of, it is necessary to compute the
profit or loss made at the point of disposal. It is computed as follows:
Profit/(Loss) = Sales Proceed – NBV at the point of disposal
34 ZENITH BANK
(If the result is positive, a profit has been made and if otherwise there is a
loss).
Take note that the original cost of the asset does not come into this
calculation.
Example 1
An asset costing ₦500,000 was purchased 3 years ago. It is being
depreciated on straight line basis over its expected useful life of 4 years
with expected residual value of ₦50,000. The asset has just been sold for
₦150,000. Calculate the profit or loss on disposal.
…35 ZENITH BANK

Solution
We know that profit or loss on disposal is given by:
Sales proceed – NBV at the point of disposal
Further more, we know that:
NBV = Cost – Accumulated depreciation
Annual depreciation is
₦500,000 − ₦50,000
= ₦112,500
4 years
36 ZENITH BANK
NBV at the point of disposal after 3 years =
₦500,000 – (112,500 × 3 years) = ₦162,500
Profit/(Loss) = ₦150,000 – ₦162,500 = - ₦12,500
i.e. a loss of ₦12,500.
Example 2
An asset costs ₦750,000 to buy and it is to be depreciated at 10% p.a. on
a reducing balance basis. If the asset is sold for ₦560,000 after 5 years.
Calculate the profit or loss on disposal.
37 ZENITH BANK
Solution
₦
Sales proceed = 560,000
NBV5 = 750,000(1 - 0.10)5 = 442,868
Profit on disposal 117,132
38 ZENITH BANK
PPE Schedule
PPE schedule is required as part of note to account when preparing
financial statement to give the breakdown of value of PPE stated on the
face of balance sheet. A typical PPE schedule is stated below:
Motor Office Land &

Cost vehicle equipment building Total
At 1 January 2019 500,000 200,000 1,000,000 1,700,000
Addition - 150,000 - 150,000
Disposal (100,000) - - (100,000)
At 31/Dec 2019 400,000 350,000 1,000,000 1,750,000
39 ZENITH BANK
Depreciation
At I Jan 2019 100,000 60,000 280,000 440,000
Charge for the yr 40,000 35,000 20,000 95,000
Disposal (20,000) - - (20,000)
At 31/Dec 2019 120,000 95,000 300,000 515,000
Carrying amount:
At 31 Dec 2019 280,000 255,000 700,000 1,235,000
At 1 Jan 2019 400,000 140,000 720,000 1,260,000
40 ZENITH BANK
Ademola OmolehinwaTraining
& Co
RATIO ANALYSIS - CASE STUDY

ADEYEMI PLC
STATEMENT OF FINANCIAL POSITION
2013 2012 2011

Non -Current Assets
N=m N=m N=m
Property, Plant and Equipment, at cost 14,450 13,272 13,042
Accumulated Depreciation 4,891 4,163 3,637
Net carrying amount 9,559 9,109 9,405
Others 40,085 39,683 35,514
Total Non-Current Assets 49,644 48,792 44,919
Current Assets
Cash 215 162 191
Receivables 3,116 3,131 3,231
Inventories 3,382 3,026 3,041
Deferred income taxes 511 466 504
Others 232 221 185
Total current assets 7,456 7,006 7,152
Total Assets 57,100 55,798 52,071

Equity 25,832 23,478 14,048
Non-Current Liabilities
Long-term notes 10,416 8,134 2,695
Other long-term liabilities 13,683 15,311 27,738
Total Non-Current liabilities 24,099 23,445 30,433
Current Liablities
Payables 1,939 1,897 1,971
Short-term debt 572 1,221 859
Others 4,658 5,757 4,760
Total Current Liabilities 7,169 8,875 7,590
Equity and Liabiities 57,100 55,798 52,071
ZENITH BANK 1 Case Study

Ademola OmolehinwaTraining
& Co
STATEMENT OF PROFIT OR LOSS ACCOUNTS
2013 2012 2011
N
=m N
=m N
=m
Sales 29,723 29,234 22,922
Cost of goods sold (COGS) 17,720 17,566 13,959
Gross profit 12,003 11,668 8,963
Selling, general & Adm. expenses 5,000 5,068 4,089
Depreciation 709 680 499
Amortization 7 962 535
Other operating expenses 173 74 (172)
Operating income (EBIT) 6,114 4,884 4,012
Interest 847 1,437 597
Income before taxes 5,267 3,447 3,415
Tax 1,873 1,565 1,414
Net income (profit after tax) 3,394 1,882 2,001
REQUIREMENTS
1. Compute the financial ratios listed in the worksheet and fill in your results.
2. Carry out a time series analysis of the company.
3. Carry out a cross-sectional analysis of the company.
Please make your comments as briefly as possible.

Training
RATIO ANALYSIS – WORKSHEET

YARO PLC ADEYEMI PLC
2013 2013 2012 2011
Current ratio 1.71 0.94
Quick ratio 1.02 0.45
Cash ratio 0.42 0.03
Receivable turnover 6.87 7.09
Inventory turnover 4.51 4.59
Payable turnover 5.83 7.08
Receivable collection period 53.13 51.48
Inventory processing period 80.93 79.52
Payable payment period 62.66 51.54
Cash conversion period 71.40 79.43
Interest coverage 3.89 6.7
Total asset turnover 0.84 0.44
NCAT 4.26 0.51
Equity turnover 5.65 1.62
Gross profit margin 36.20% 39.10%
Operating profit margin 14.05% 17.50%
Net profit margin 6.88% 8.73%
DuPont Analysis:
Return on equity 44.44% 14.24%
= Net profit margin 6.88% 8.73%
× Total asset turnover 0.84 0.44
× Equity multiplier 7.69 3.71
Note: Cash Ratio = (Cash + Short – Term Marketable Investments) ÷ Current Liabilities
NCAT = Non – current asset turnover
*Cash conversion period is the same as working capital cycle
Purchases can be calculated from the following cost of sales formula:
*Cost of sales= Opening Inventories + Purchases – Closing Inventories

THE ACCOUNTING PROCESS

INTRODUCTION
In this section, we shall discuss the accounting sequence,
which is represented diagrammatically below:
Business
Journal General Trial Financial
Transaction
Entry Ledger Balance Statement
(Source
document)
What Is The Double -Entry Principle ?

It is the basis on which all transactions in accounting are recorded
and classified. From our knowledge of the previous section, it can be
observed that all transactions have a dual effect in our books of
account. e.g.
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Transaction : Bought motor vehicle for N5m by cheque
Dual Effect: Increases assets (motor vehicle) N5m

Reduces Asset ( bank) N5m
Transaction: Paid wages of N75,000 by cash
Dual Effect : Increases expenses ( wages) N75,000

Reduces Asset (cash) N75,000
3 ZENITH BANK
Transactions are recorded in the books of

account in line with the double-entry principle,
which requires that the dual effect of every
transaction should be reflected by posting a
debit entry and a corresponding credit entry.
In order to maintain the equality of the
accounting equation, debit must always be equal
to credit.
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What is the Meaning of Debit and Credit ?

Debit’ (DR.) and ‘Credit’ (CR.) are the technical
accounting terms used to describe the direction of
changes in each account that appears in the
financial statements.
How do we know which account to debit &
which one to credit ?
In the previous section, we learnt that the
accounting equation is represented by:
5 ZENITH BANK
Assets = Liabilities + Capital

Where, Capital = Original contribution (capital)
+ Profit
And, Profit = Revenue - Expenses
Therefore, the original accounting equation can be
expressed thus:
Assets + Expenses = Liabilities + Original Contribution
+ Revenue
DR. DR. CR. CR. CR.
6 ZENITH BANK
As a rule, the accounts on the left hand side of the

equality sign are debits, while the accounts on the right
hand side of the equality sign are credit in nature.
This implies that where any of the accounts on the left
hand side of the equation increases, such account will
be debited and vice-versa. For instance, when an
asset is acquired, we will debit the related asset
account because it is on the left hand side of the
equality sign.
7 ZENITH BANK
On the other hand, where assets are utilized or

disposed, we will credit the related asset to record
the reduction.
Similarly, when we incur a debt, the related liability
account will be credited because it is on the right
hand side of the equality sign. On the other hand,
when the debt is repaid, the related liability account
will be debited to record the reduction.
8 ZENITH BANK
Journal Entry
It is also known as “ Book of original entry”
because transactions are first recorded there
before being entered into the accounts. A journal
is a document in which each business transaction
is usually recorded in a chronological order. A
journal shows for each transaction the debit and
credit entries required in the relevant accounts.
9 ZENITH BANK
Example 2-1
The following transactions took place in the month of
June 2013 in Local Bank Ltd. (LBL)
1 June Started business with N100,000,000 in
its CBN current account
2 June Bought building for N25m paying by
cheque
3 June Bought motor vehicles for N15m from
first-In-Town Cars paying by bank drafts.
10 ZENITH BANK
4 June Borrowed N60m from Rich Bank Plc.

5 June Advanced N20m to Agric Ltd. at 18% p.a.
6 June Placed N5m with Strong Bank Ltd. under
Inter-Bank placement.
7 June Took delivery of Computer Equipment of
N12m from City Computers Ltd. (CCL) on
credit.
8 June Invested N40m on Treasury Bills with tenor
of 45days
11 ZENITH BANK
The necessary journal entries are shown below:
DR. CR
June 1 Bank (CBN) 100
Equity 100
Being the amount introduced into
the business by shareholders
June 2 Building 25
Bank 25
Being payment for building
June 3 Motor vehicles 15
Bank 15
Being payment for motor vehicles
June 4 Bank 60
Rich Bank Plc. 60
Being amount borrowed from Rich
Bank Plc.
12 ZENITH BANK
June 5 Loans & Advances 20
Bank 20
Being loan to Agric Ltd
June 6 Inter - Bank Placement 5
Bank 5
Being Inter - Bank Placement
June 7 Office Equipment 12
Payables (CCL) 12
Being purchase of computer paid partly
by cash and partly by credit.
June 8 Short - Term Investments (T. Bill), 40
Bank 40
Being Investment in T. Bills
13 ZENITH BANK
Ledger Accounts
The next step of the accounting system involves posting the
journal entries into ledger accounts. Posting is the process of
transferring the debit and credit entries recorded in each journal
entry to the relevant accounts in the ledger.
A typical ledger account
DR. Account Name CR
N N
Date x - ref. Account........... Date x - ref. Account................
14 ZENITH BANK
Ledger accounts is also known as T-accounts

because of it semblance to the alphabetical
letter “T”. These are the accounts into which
transactions are posted from the source
documents. A separate ledger account is
maintained for the different classes of accounts
e.g. cash account, motor vehicle account,
customer’s deposit account, loan account, etc.
15 ZENITH BANK
Asset / Expenses Account
Debit (DR.) Credit (CR)
Increase in Assets/ Expenses Decrease in Assets/ Expenses
Liabilities /Capital /Revenue Account

Debit (DR.) Credit (CR)
Decreases in Liabilities/Capital/ Revenue Increases in Liabilities/Capital/ Revenue
“Closing Off” Account

After recording all transactions for a period, we have to summarise
each account before we can extract a trial balance. This is called
closing off an account and the steps involved depend on whether the
particular account is a statement of financial position or statement of
profit or loss.
16 ZENITH BANK
This difference in treatment arises because

statement of financial position items by their nature
are perpetual, therefore the closing balance as at
year-end will naturally represent the opening
balance for the next period e.g. cash account. On
the other hand, profit or loss accounts terminate at
the end of an accounting year and their balances are
not carried into the following accounting year e.g.
salaries account.
17 ZENITH BANK
The steps are as follow:

Statement of financial position items ( Assets,
Liabilities & Owners’ Equity)
i) Add up both (DR. & CR) sides of the accounts
ii) Determine the greater side
iii) Foot the greater total on both sides
iv) Insert balancing figure on the lesser side with a
caption “Balance Carried Down” (“bal c/d”) which
represents the closing balance at the end of the
period
18 ZENITH BANK
v) Transfer balancing figure to the opposite side with a

caption “Balance Brought Down” (“bal b/d”), which
represents the opening balance at the beginning of the
subsequent period.
Statement of Profit or Loss (Revenues & Expenses)
i-iii. Same as above
At accounting year-end, steps iv. and v. above becomes
iv. Insert balancing figure on the lesser side with a caption “
transfer to profit & loss account “which represents the
amount to be recognised as gain/revenue earned or
losses/expenses incurred for the accounting year.
19 ZENITH BANK
Bank A/C
Nm Nm
June 1 Capital ( Equity) 100 June 2 Building 25
Rich Bank 60 June 3 Motor vehicles 15
June 5 Loan & Advances 20
June 6 Inter- Bank Placement 5
June 8 Short-Term Investments 40
_____ June 30 Bal. c/d 55
160 160
July 1 Bal. b/d 49
20 ZENITH BANK
Capital A/C
Nm Nm
June 30 Bal. c/d 100 June 1 Bank 100
___ ___
100 100
July 1 Bal. b/d 100
Building A/C
Nm Nm
June 2 Bank 25 June 30 Bal. c/d 25
___ ___
25 25
July 1 Bal. b/d 25
21 ZENITH BANK
Motor Vehicle A/C
Nm Nm
15 15
July 1 Bal. b/d 15
Rich Bank A/C

Nm Nm
June 30 Bal. c/d 60 June 4 Bank 60
___ ___
60 60
July 1 Bal. b/d 60
22 ZENITH BANK
Loans and Advances A/C
Nm Nm
July 1 Bal. b/d 20
Inter-Bank Placement A/C
Nm Nm
July 1 Bal. b/d 5
Office Equipment A/C
Nm Nm
June 7 Payables 12 June 30 Bal. c/d 12
12 12
July 1 Bal. b/d 12
23 ZENITH BANK
Payables A/C
Nm Nm
June 30 Bal. c/d 12 June 7 Office Equipment 12
___ ___
12 12
July 1 Bal. b/d 12
Short - Term Investment ( T.Bills)

Nm Nm
___ ___
40 40
July Bal. b/d 40
24 ZENITH BANK
Trial Balance
The Trial balance is an account in which all the
balances on the individual accounts are listed or
summarized as at a particular point in time.
25 ZENITH BANK
The debit balances are shown under the debit column,

while the credit balances are shown under the credit
column. If the double entry principle has been correctly applied,
then it follows that the total of the debit and credit column should
be the same.
The trial balance serves 2 purposes namely:
1. To check on the arithmetical accuracy of the entries made
in the ledgers
2. It forms the basis upon which the statement of profit or
loss and statement of financial position are prepared.
26 ZENITH BANK
Using the above ledger balances, a trial balance can be

extracted as detailed.
Account Name DR. CR
Nm Nm
Bank 55
Capital 100
Building 25
Motor vehicles 15
Rich Bank 60
Loans & Advances 20
27 ZENITH BANK
Inter-Bank Placement 5
Office Equipment 12
Payables 12
Short - term Investment 40 ___
166 166
AT THIS LEVEL YOU HAVE NOW GOT THE FIRST ‘A’

OF THE PRESTIGEOUS ‘ACA’!!
28 ZENITH BANK
Question 1
You are required to complete the following table showing which accounts
are to be debited and which are to be credited:
Accounts to Account to
be debited be credited
i) Paid Alhaji Dan Jubril a supplier of goods by cash...................................
ii) Bought motor vehicle for cash...................................................................
iii) Repaid B.Alabi’s loan by cash......................................................................
iv) Paid Toba Abisoye for goods supplied by cheque......................................
v) Sold motor van for cash..............................................................................
29 ZENITH BANK
vi) Mr. B. Sani a customer pays the business by

cash...................................
vii) The owner of the business puts a further amount to the
business by cheque.....................................................................
viii) A loan is received from Chief Mike Nnamdi.................................
ix) Mr. A. Johnson a customer pays the business by cheque.........
x) Rent paid by cheque in respect of the business premises…......
30 ZENITH BANK
Question 2
The following transactions took place in Aloba Bank Plc in the year 2013
Jan. 1 Commenced business with N50,000,000, paid into CBN Account
Jan. 22 Acquired office building for N25,000,000, by cheque
Feb. 2 Bought a car for N3,500,000 , paying by cheque
Feb. 14 Bought furniture for N150,000, paid by cheque
Mar. 9 Received Deposit of N750,000 from a customer & paid into the bank
Apr. 10 Issued a loan of N1,200,000 to Mr. Okon, a customer
May 21 Bought office stationery, paying =N70,000 by cheque
Oct. 14 Invested N5,000,000 in Olori Investment Ltd, by cheque.
You are required to write up the necessary journal entries
31 ZENITH BANK
Question 3
The following transactions relate to Lagos Bank
August1 Started business with N800m paid into the bank
2 Bought stationery by cheque N3m
4 Received deposit from Tope N90m
7 Granted loan to Yaro N80m
8 Withdrew N5m cash from bank
10 Paid Insurance by cash N4m
11 Bought equipment on credit from EG. Ltd. N5m
19 Took N70m from Bank
20 Paid rent by cheque N1m
32 ZENITH BANK
22 Received N2m cheque from Yaro a loan repayment

28 Received rent N2m in cash for part of premises sub-let
30 Paid interest of N6m on deposit, by cheque
30 Received N90m as income for foreign exchange
transaction
You are required:

a) Post the above transactions into the related ledger
accounts
b) Extract a trial balance.
33 ZENITH BANK
Question 4
The following transaction took place in the month of March 20x7 in
Best Bank Plc (BBP)
1/3 Started business with ₦800,000,000 in its CBN current
account
2/3 Withdrew ₦130,000,000 from bank.
3/3 Purchased building for ₦50,000,000 paying by cheque.
3/3 Purchased Motor vehicles for ₦12,000,000 on credit from
Tayo Limited.
4/3 Purchased additional building for ₦10,000,000 paying by cash.
5/3 Bought Office equipment for ₦35,000,000 from Wale Nigeria
Limited paying by bank drafts
34 ZENITH BANK
6/3 Took ₦40,000,000 from bank.

11/3 Received cash deposit of ₦50,000,000 from a Mr Johnson.
15/3 Mallam Yusuf an account holder with TFC bank made a transfer
of ₦22,000,000 Mr Johnson’s account with Best bank Plc
16/3 Mr Johnson transferred ₦10,000,000 to Miss Lizzy (an
account holder with another Bank) from his account with Best
bank Plc
17/3 Lent Kenny Plc ₦115,000,000.
18/3 Advanced ₦18,000,000 to Hope Ltd. At interest of 22% per
annum
19/3 Placed ₦17,000,000 with Golden Bank Plc under inter-bank
placement
35 ZENITH BANK
21/3 Invested ₦65,000,000 on treasury bills with tenure of 60days

by cheque.
22/3 Paid salaries for the month ₦120,000,000 by cheque.
23/3 Bought stationeries ₦2,000,000 by cash.
24/3 Paid Electricity bill for the month ₦1,000,000 by cheque.
25/3 Received ₦230,000,000 as income from foreign exchange
transaction.
26/3 Received interest of ₦17,000,000 from loans to customers
27/3 Paid interest of ₦4,000,000 on customers’ deposits
Required:
Prepare journal entries to record the above transactions
36 ZENITH BANK
Solution
The necessary journal entries are shown below
Date Particulars DR. ₦(Mill) CR. ₦(Mill)
1/3 Bank (CBN) 800
Equity 800
Being the amount introduced into the
business by shareholders
2/3 Cash 130
Bank 130
Being cash withdrawn for business use
37 ZENITH BANK
3/3 Building 50
Bank 50
Being building acquired by cheque
3/3 Motor vehicles 12
Tayo Limited (Payables) 12
Being Motor vehicles acquired on credit
from Tayo
4/3 Building 10
Cash 10
Being building acquired by cash
5/3 Office equipment 35
Bank 35
Being office equipment acquired by cheque
38 ZENITH BANK
6/3 Cash 40
Bank 40
Being cash withdrawn for business use
11/3 Cash 50
Mr Johnson 50
Being cash deposit received from Mr Johnson
15/3 Bank 22
Mr Johnson 22
Being transfer to Mr Johnson’s account
16/3 Mr Johnson 10
Bank 10
Being transfer from Mr Johnson’s account
39 ZENITH BANK
17/3 Kenny 115

Bank 115
Being loan to Kenny
18/3 Hope Ltd 18
Bank 18
Being cash deposit received from Mr Johnson
19/3 Golden Bank 17
Bank 17
Being inter-bank placement with Golden Bank
21/3 Treasury bills investment 65
Bank 65
Being treasury bills purchased by cheque
40 ZENITH BANK
22/3 Salaries 120

Bank 120
Being payment of salaries for the month
of March 20x7
23/3 Stationeries 2
Bank 2
Being payment of stationeries for the month
of March 20x7
25/3 Bank 230
FOREX income 230
Being income from FOREX transactions
41 ZENITH BANK
26/3 Bank 17
Interest income 17
Being interest income from loans & advances
27/3 Interest expense 4
Bank 4
Being interest cost on customers’ deposits
42 ZENITH BANK
UNDERSTANDING FINANCIAL
STATEMENTS
INTRODUCTION
A firm communicates financial information to
the users through financial statements and
reports. Financial statements contain
summarised information of the firm’s financial
affairs, organised systematically. They are the
means to present the firm’s situation to users.
2 ZENITH BANK
USERS OF FINANCIAL STATEMENTS.

The Owners
These have provided a substantial proportion
of the organisation’s financial resources and
are interested not only in the earnings which
result from management use of these
resources but also in what proportion they
can reasonably withdraw for personal use
3 ZENITH BANK
without making the organisation worse off than

before in its capacity to use these resources to
generate future earnings. In companies, such
withdrawals of earnings are called dividends.
Creditors
These have supplied goods and services to the
organisation and are interested in receiving
payment for them.
4 ZENITH BANK
There must, therefore, be information available

to potential creditors which show the
organisation’s financial ability to meet its
obligations to creditors.
Suppliers of Loans (e.g. Banks)
Information is needed by this group about the
organisation’s ability to pay interest on loans
and repay the capital when it becomes due.
5 ZENITH BANK
Employees
These have provided labour and are interested in
being adequately remunerated for their services.
They require information about the financial
results of the organisation’s activities on which
their remuneration will be based, and also on the
organisation’s ability to provide a rewarding and
stable employment in the foreseeable future.
6 ZENITH BANK
Government
Government imposes tax on profits. Where the
organisation has made a profit during a given
period, Government will be interested in the amount
in order to assess the organisation for tax liability.
Government also uses business accounting reports
for planning and analysis of economic activities in a
country, such as during the preparation of the
development plan.
7 ZENITH BANK
Management
Management has responsibility for the
survival of the organisation on behalf of the
owners. The responsibility includes planning
what resources are to be acquired and how
they are to be used; ensuring that suppliers
of these resources are remunerated,
8 ZENITH BANK
constantly reviewing the different activities of the

organisation in terms of the relationship between
the cost and value of each unit of activity;
exercising overall control over the functioning of
the organisation; the overall result of the
organisation’s activities as measured by its profit
or loss during a specific period and the financial
position at a given point in time.
9 ZENITH BANK
In order to provide some assurances as to the

information provided in the financial
statements and related notes, the financial
statements are audited by independent
accountants who express an opinion on
whether the financial statements fairly portray
the company’s performance and financial
position.
10 ZENITH BANK
Financial Statements
The key financial statements that are the focus
of analysts are the statement of financial
position, statement of profit or loss and
statement of cash flows. The statement of
profit or loss and statement of cash flows
portray different aspects of a company’s
performance over a period of time.
11 ZENITH BANK
The statement of financial position portrays

the company’s financial position at a given
point in time.
In addition to the financial statements, a
company provides other information in its
financial reports that is useful to the
financial analyst.
12 ZENITH BANK
As part of his or her analysis, the financial

analyst should read and assess this
additional information, which includes:
• notes to the financial statements
• statement of changes in equity
• chairman’s report
• the external auditor’s report
13 ZENITH BANK
The following sections illustrate the major financial statements.

Credit Plc
Statement of financial Position As at December 31, 2019
Non-Current Assets Cost Accumulated Carrying Amount
Depreciation
Nm Nm Nm
Land and buildings 65 20 45
Plant and Machinery 25 14 11
Motor Vehicles 24 15 9
114 49 65
14 ZENITH BANK
Current Assets
Inventory 30
Cash and bank 5
Trade Receivables 27
Prepayments 10
72
Total Assets 137
15 ZENITH BANK

Equity
Ordinary Shares of N1 each 10
Shares premium 30
Retained earnings 20
Shareholders’ fund or equity 60
Non current liabilities
20% loan notes (2025 - 2027) 25
16 ZENITH BANK
Current Liabilities
Trade payables 15
Bank borrowing 12
Interest payable 3
Customers’ deposits 10
Taxation 12 52
137
17 ZENITH BANK
Statement of change in equity

Ordinary Retained Share
Share Capital Earnings Premium
Balancing at the beginning 10 9 30
Profit for the year 29
Dividend paid (18)
Balance at the end 10 20 30
18 ZENITH BANK
CREDIT PLC
Statement of Profit or loss and other comprehensive
income for year ended 31 December, 2019
Nm
Turnover 180
Cost of Sales (108)
Gross profit 72
Distribution costs (8)
Administration expenses (10)
19 ZENITH BANK
Earnings before interest and tax (EBIT) 54

Interest paid on bank overdraft (8)
Interest on 20% loan notes (5)
Profit before taxation 41
Taxation on ordinary activities (12)
Profit after taxation 29
Dividends paid (18)
20 ZENITH BANK
Retained earnings for the year 11

Retained earnings at the beginning 9
Retained earnings at the end 20
21 ZENITH BANK
STATEMENT OF FINANCIAL POSITION (SFP)

The statement of financial position or
statement of financial condition) presents a
company’s financial position by disclosing
resources the company controls (assets) and
what is owes (liabilities) at a specific point in
time.
22 ZENITH BANK
Thus, the SFP of a firm prepared on 31

December 2013, for example, reveals the
firm’s financial position on this particular
date. It is a snapshot of the financial
position of the firm at the close of the
firm’s accounting period.
23 ZENITH BANK
ASSETS
Assets, representing economic resources,
are the valuable possessions owned by the
firm. These possessions should be capable
of being measured in monetary terms.
Assets may be classified as non-current
assets and current assets.
24 ZENITH BANK
NON CURRENT ASSETS

Non-current assets are held for periods longer
than one year. They are held for use in the
business, and not for the purpose of sale.
Examples of non-current assets include:
* Land and building
* Plant and machinery e.g. generators
* Motor vehicles
25 ZENITH BANK
* Computers
* Furnitures and fittings, etc.
All of these are referred to as tangible assets.
They are recorded at cost.
Costs of tangible non-current assets are allocated
over their useful lives. The amount so allocated each
year is called depreciation. Costs of tangible non-
current assets are reduced every year by the
amount of depreciation.
26 ZENITH BANK
Depreciating an asset is a process of allocating

cost and does not involve any cash outlay.
COST
This represents the original cost of total non-
current assets. When accumulated depreci-
ation is subtracted from the original cost, the
difference is called the carrying amount.
27 ZENITH BANK
LONG-TERM INVESTMENTS
These represent the firm’s investment in shares,
debentures and bonds of other companies for
profits and control. These investments are held
for a period of time greater than the accounting
period. Usually, long-term investments are shown
at the original cost, but the current price may
also be indicated.
28 ZENITH BANK
CURRENT ASSETS
These are assets that are expected to be
converted into cash within one year. Current
assets include items like cash, trade debtors
(receivables), stock (inventory), prepay-
ments, dividends receivable, etc.
29 ZENITH BANK
TRADE RECEIVABLES
These represent the amounts due from
customers to whom goods or services have been
sold on credit.
These amounts are generally realisable in cash
within the accounting period. All accounts
receivable may not be realised by the firm. Some
may remain uncollected. Debts which will never
be collected are called bad debts.
30 ZENITH BANK
INVENTORY
This includes raw materials, work-in-
progress and finished goods in case of
manufacturing firms. A trading business
may not have raw material and work-in-
progress inventories as it has no
manufacturing activity.
31 ZENITH BANK
PREPAYMENTS
Prepayments represent expenses paid for
benefits of which will be enjoyed in the future.
Examples include prepaid insurance, prepaid
rent, prepaid electricity, prepaid telephone,
etc. They are current assets because their
benefits will be received within the accounting
period.
32 ZENITH BANK
ACCRUED INCOMES
These are benefits which the firm has earned,
but they have not been received in cash yet.
Examples include:
• Interest earned but not yet received;
• Dividend earned but not yet received
• Commission earned but not yet received, etc.
33 ZENITH BANK
These items are treated as current assets

because it is expected that they will be
converted to cash one year.
LIABILITIES
These are debts payable in the future by the
firm to its creditors. They represent economic
obligations to pay cash or to provide goods or
services in some future period.
34 ZENITH BANK
Generally, liabilities are created by

borrowing money or purchasing goods or
services on credit.
Liabilities are of two types:
1. Non-current liabilities.
2. Current liabilities.
35 ZENITH BANK
NON-CURRENT LIABILITIES
These are obligations or debts payable in a
period of time greater than one year. Long-
term liabilities usually represent borrowing
for a long period of time. They include
debentures, bonds, and secured long-term
loans from financial institutions.
36 ZENITH BANK
LOAN NOTES
Loan notes are issued by a firm to the
public to raise debt capital. A loan note
or a bond is a general obligation of the
firm to pay interest and return the
principal sum as per the agreement.
37 ZENITH BANK
CURRENT LIABILITIES
These are debts payable within one year.
Examples of current liabilities include:
• Trade payables- suppliers of goods and services
that are payable within one year.
• Accruals- expenses already incurred but not yet
paid for e.g. accrued interest expenses accrued
electricity, accrued salaries and wages, etc.
38 ZENITH BANK
• Unearned Income -Money already recei-

ved for goods and services to be supplied
in the future.
• Current portion of long-term loans- this
represents portion of long-term loan
which is payable within one year.
• Bank overdrafts
39 ZENITH BANK
EQUITY
The financial interests of owners are called
owners’ equity. The owners’ interest is residual
in nature, reflecting the excess of the firm’s
assets over its liabilities. As liabilities are
claims of outside parties, equity represents
owners’ claim against the business entity as of
the balance sheet date.
40 ZENITH BANK
Initially, owners’ equity arises on account of the

funds invested by them. But it changes due to
earnings (profits) of the firms and their
distribution. The firm’s earnings (or losses) do
not affect the creditors’ claims. Owner’s equity
will increase when the firm makes earnings and
retains whole or part. If losses are incurred by
the firm, owners’ claim will be reduced.
41 ZENITH BANK
SHARE CAPITAL
In case of a company, owners are called
shareholders. Therefore, owners’ equity is
referred to as shareholders’ equity or
shareholders’ funds. Shareholders equity
is made up of a number of components.
42 ZENITH BANK
PAID UP CAPITAL
This represents the amount of funds
directly contributed by the shareholders.
SHARE PREMIUM
This represents the amount paid by
shareholders over and above the face value
of the shares.
43 ZENITH BANK
For example, each unit of Zenith bank

Shares as at the time of writing this paper
(23/12/2019), traded at N6.60 on the NSE.
If the bank were to make a public offer of
N1,000,000 shares, at the quoted price, the
equity account will be affected as follows:
44 ZENITH BANK
N
Share capital (N0.50 x 1,000,000) 500,000
Share premium N(N6.60 – N0.50) x 1,000,000 6,100,000
Total capital raised (N6.60 x 1,000,000) 6,600,000
RETAINED EARNINGS
These represent total earnings to date that have not
been otherwise distributed or appropriated.
45 ZENITH BANK
RELATIONSHIP BETWEEN ASSETS, LIABILITIES AND

OWNERS’ EQUITY
THE ACCOUNTING EQUATION
We have discussed that assets are resources of the
firm that are acquired from funds provided by
outsiders, known as liabilities and funds provided by
owners, known as owners’ equity. In other words,
assets represent the outsiders’ and owners’
investments.
46 ZENITH BANK
At commencement, the resources (assets)

needed to operate will be provided by the
owners (capital) if the owners are the only
ones how have supplied the assets, then the
following equation holds true:
Assets = Owners’ Equity
47 ZENITH BANK
Example 1-1
Assume Lagos Bank Plc (LBP) started business on
June 1, 2013 with N2bn, which was contributed by its
shareholders. The bank acquired the following items:
Nm
Building 750
Office Equipment 250
Motor vehicles 100
Furniture 200
48 ZENITH BANK
The remaining cash was left for operations. The equation can
be summarised as follows:
Assets Nm
Building 750
Motor Vehicles 100
Furniture 200
Cash in hand 700
Total Assets 2000
Financed by:
Capital (Owners’ Equity) 2000
49 ZENITH BANK
The total value of assets (N2000m) is equal to the

initial contribution by shareholders (N2000).
In practice however some of the assets may have
been provided by third parties. A customer may
deposit money with the bank or a supplier may
provide goods on credit. The equation now
becomes:
Assets = Owners’ Equity + Liabilities
50 ZENITH BANK
The whole of accounting is based in this

equation and it holds true no matter the
complexity or number of transaction involved.
Example 1-2
Assume the owner’s equity is insufficient to
fund all the assets required by the business
and the bank acquired a leasehold from LSDP at
N250m, which it is yet to pay for, then the
51 ZENITH BANK
equation can be summarised as follows:

Assets Nm
Leasehold 250
Building 750
Motor Vehicles 100
Furniture 200
Cash in hand 700
Total Assets 2250
Capital and Liabilities:
Capital 2000
Payables 250
2250
52 ZENITH BANK
The total assets of the business is now N2250m.

This is financed by owners equity, which is still
N2000m and payables of N250m (liability).
Another way of expressing the equation is as
follows:
Assets - Liabilities = Owners’ Equity
53 ZENITH BANK
Since Assets less liabilities equals net assets, it

could be re-written as:
Net Assets = Owners’ Equity
Net Asset represents the portion of the total
assets financed solely by owners’ equity. The
equation holds true for every organisation
irrespective of the nature or size.
54 ZENITH BANK
Transactions and The Accounting Equation

Given that the SFP indicates the financial
position of an enterprise at a given point in
time, successive transactions would maintain
the accounting equation on which the SFP
rests, though its dimensions and its
constituent elements would vary.
55 ZENITH BANK
It is possible to record the effects of successive
transactions on the SFP equation.
Example 1-3
The following transactions took place in the month
of June 2013 in Lagos Bank Plc.
June 2 Started business with N10,000,000 in
its CBN current account
June 3 Acquired office building for N5,000,000
paying by cheque
56 ZENITH BANK
June 5 Bought motor vehicle for N2,000,000

by cheque
June 8 Purchased office equipment from Bank
supplies Ltd. (BSL) on credit for
N2,000,000
June 12 Bought Treasury Bills of N1,000,000 by
cheque
June 13 Inter-bank borrowing of N3,000,000
from Strong Bank Plc ( SBP)
57 ZENITH BANK
Solution :
Transaction 1: Started business with N10,000,000 in
its CBN current account.
Effect : Asset ( Bank) increases by N10,000,000
Equity ( Capital) increases by N10,000,000
Statement of financial position as at June 2
Assets Nm
Bank 10
Capital 10
58 ZENITH BANK
Transaction 2: Acquisition of office building for N5m and paid by
cheque
Effect: Asset (Building) increases by N5m
Asset (Bank) decreases by N5m
Assets Nm
Bank 5
Building 5
Total Assets 10
Capital 10
59 ZENITH BANK
Transaction 3: Bought motor vehicle for N2m

Effect : Affects (motor vehicle) increases by N2m
Assets ( Bank ) decreases by N2m
Assets Nm
Bank 3
Motor Vehicle 2
Building 5
Total Assets 10
Capital 10
60 ZENITH BANK
Transaction 4: Purchased office equipment for N2m
on credit
Effect : Asset ( Equipment) increases by N2m Liability
(BSL) increases by N2m
Assets Nm
Bank 3
Motor vehicle 2
Equipment 2
Building 5
Total Assets 12
61 ZENITH BANK
Capital & Liabilities

Capital 10
Liability:
Payable 2
12
Transaction 5: Bought Treasury Bill of N1m with cheque
Effect Asset (T.Bill) increases by N1m
Asset ( Bank) decreases by N1m
Statement of financial position as at
June 12
62 ZENITH BANK
Assets Nm
Bank 2
T.Bills 1
Motor Vehicle 2
Equipment 2
Building 5
12
Capital & Liabilities
Capital 10
Liability
Payables 2
63 ZENITH BANK 12
Transaction 6: Inter-Bank borrowing of N3,000,000.
Effect : Asset ( Bank) increases by N3m
Liabilities (SBP) increases by N3m
Assets Nm
Bank 5
T.Bills 1
Motor Vehicles 2
Equipment 2
Building 5
Total Assets 15
64 ZENITH BANK
Capital & Liabilities:

Capital 10
Liabilities:
Loan (SBP) 3
Payables(BSL) 5
15
65 ZENITH BANK
Discussion Question
Yemi Plc was incorporated on 1 March 2013. On
that day, the company acquired the following:
Nm
Motor vehicle 5
Building 10
Equipment 2
Furniture 2.50
66 ZENITH BANK
All items were paid for apart for the motor
vehicle. Cash in hand after these transaction
was N0.50m.
Determine the amount invested by the owners
and draw up the SFP as at 1 March 2013.
67 ZENITH BANK
Solution :
Assets = Liabilities + Capital - Assets are
Nm
Cash 0.50
Motor vehicles 5
Building 10
Equipment 2
Furniture 2.50
20m
Liability is payable due on vehicle, that is, N5m.
Capital = Assets - Liabilities = N20m - N5m = N15m
68 ZENITH BANK
Yemi Plc.
Statement of financial position as at 1 March 2013
Assets Nm
Cash 0.5
Motor vehicle 5
Furniture 2.50
Equipment 2
Building 10
Total Assets 20
69 ZENITH BANK
Capital & Liabilities:
Capital 15
Liability
Payable 5
20
In our discussion so far on the accounting equation, we
have familiarised ourselves mainly with statement of
financial position items, i.e. assets, liabilities and capital.
Let now introduce Profit & Loss items i.e. revenue,
expenses, gains & losses into the accounting equation.
70 ZENITH BANK
Recall that profit is the reward for risk taken by the
owners and therefore affects equity (shareholders’ funds)
From the original accounting equation
1. Assets = Liabilities + Capital
Where, Capital = Original contribution + Profit
Therefore, equation 1 above can be re-written as follows:
2. Assets = Liabilities + Original Contribution + Profit
Where, Profit = Revenue - Expenses
Therefore, equation 2 above can be expressed as follows:
71 ZENITH BANK
3. Assets = Liabilities + Original Contribution + Revenue - Expenses
Therefore, equation 3 above can be expressed as follows:
4. Assets + Expenses = Liabilities + Original Contribution + Revenue
72 ZENITH BANK
Exercises - Question 1
You are to complete the gaps in the following table:
Assets Liabilities Capital
N N N
(a) 55,000 16,900 ?
(b) ? 17,200 24,400
(c) 36,100 ? 28,500
(d) 119,500 15,400 ?
(e) 88,000 ? 62,000
(f) ? 49,000 110,000
73 ZENITH BANK
Question 2
Classify the following items into liabilities and assets:
(a) Motor vehicles (f) Owing to bank
(b) Premises (g) Cash in hand
(c) Trade payables (h) Loan from D Jones
(d) Inventory (i) Machinery
(e) Trade receivables
74 ZENITH BANK
Question 3
Which of the following are shown under the wrong headings:
Assets Liabiliies
Cash at bank Loan from Tayo
Fixtures Machinery
Trade payables Motor vehicles
Building
Inventory
Trade receivables
Capital
75 ZENITH BANK
Question 4
A Francis sets up a new business. Before
he actually sells anything, he has bought
motor vehicle N2m, premises N5m stock of
goods N1,000,000. He did not pay in full for
his Inventory and still owes N400,000 in
respect of them.
76 ZENITH BANK
He had borrowed N3m from Top Bank. After

the events just described, and before
trading starts, he has N100,000 cash in
hand and N700,000 cash at bank.
Prepare the SFP and calculate capital.
77 ZENITH BANK
Question 5
Draw up A Demola’s statement of financial position from the
following as at 31 December, 2019
N
Capital 2,375,000
Trade receivables 495,000
Trade payables 245,000
Fixtures 550,000
Inventory 880,000
Cash at bank
ZENITH BANK
125,000
78
Question 6
New Limited kept very few records of its transactions. Its
assets and liabilities were as follows:
1 January 2019 31 December 2019
N N
Distributors’ deposits 52,500 71,250
Land & Buildings 86,250 101,250
Investments 70,875 82,125
Bank deposits 58,880 64,500
Fittings 40,500 40,500
Cash
79 ZENITH BANK 7,875 12,300
i) Prepare a SFP as at 1 Jan. 2019

ii) Prepare a SFP as at 31 Dec. 2019
iii) Calculate the profit or loss for the year.
Note: New Ltd is in the cement manufacturing industry.
80 ZENITH BANK

Basic Accounting Financial Analysis

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Basic Accounting Financial Analysis

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Accounting Equation Matrix

Assets, Expenses Capital, Liabilities, Revenue

1 © Ade Omolehinwa, MSc. (Finance), FCA, FCMA, CIIA

Key current assets and current liabilities

FINISHED GOODS WORK IN PROGRESS

finished goods inventory

2018 2019 2020

DAYS DAYS DAYS

Raw materials raw material inventory

Receivables Receivables × 365 73 88 92

Working Capital Cycle 151 180 195

ASSESSING FINANCIAL HEALTH OF A FIRM WITH RATIO ANALYSIS: ABC PLC

TABLE 01: PROFIT OR LOSS ACCOUNT FOR YEAR ENDED 31 DECEMBER

TABLE 02: STATEMENT OF COST OF GOODS SOLD

ZENITH BANK 1 Financial Ratio Analysis

TABLE 03: STATEMENT OF FINANCIAL POSITION

2011 2012 2013

Equity and Liabilities

Non -Current Liabilities

ZENITH BANK 2 Financial Ratio Analysis

($ millions) 1995 1996 1997

Total revenue $1,016.9 $984.2 $1,168.2

Change from prior year – 3.2% 18.7%

Gross accounts receivable $216.2 $213.4 $295.6

Change from prior year –1.3% 38.5%

Receivables/revenue 21.3% 21.7% 25.3%

Change in receivables/revenue 0.7% 0.4% 3.6%

Days' sales outstanding 77.6 79.1 92.4

Accounts receivable turnover 4.7 4.6 4.0

Source: Based on information in original company 10-K filings.

1997 Pro Forma

($ millions) 1995 1996 1997

Change from prior year – 3.2% 18.7% 18.7%

Gross accounts receivable $216.2 $213.4 $295.6 $354.6

Receivables/revenue 21.3% 21.7% 25.3%

Change in receivables/revenue 0.7% 0.4% 3.6%

Days' sales outstanding 77.6 79.1 92.4

Accounts receivable turnover 4.7 4.6 4.0

Source: Based on information in original company 10-K filings.

This is what banks do

The expected loss model in IFRS 9 is complex and it requires banks to

It is helpful to understand that the estimate of losses at any point in

Examples of Financial Instruments Contracts

FINANCIAL RATIO ANALYSIS

Nature of Ratio Analysis

The absolute accounting figures

For example, a net profit of N20m may look

Ratios help to summarise large

liabilities; the ratio indicates a relationship

It measures the firm’s liquidity. The

Time Series Analysis

or remained constant over time. The

This kind of a comparison indicates

This sort of analysis, known as the industry

But there are certain practical

Sometimes differences may be so

If it is possible to standardise the

COMMON RATIOS USED IN FINANCIAL

what aspects of performance a ratio

The common categories are itemized

These categories are not mutually exclusive; some

INTERPRETATION AND CONTEXT

and to the company’s prior periods (trend