ASSESSMENT OF FACTORS AFFECTING PROFITABILITY OF

COMMERCIAL BANK OF ETHIOPIA

(THE CASE OF COMMERCIAL BANK OF ETHIOPIA, ARBA MINCH

BRANCH)

A senior essay for the partial fulfillment of the requirement of B.A. Degree in Accounting and
Finance

Submitted to:

Arba Minch University

College of Business and Economics

Department of Accounting and Finance

PREPARED BY: SOLOMON MELKAMU

ID NO: RBE/507/06

Advisor: KEDIR SEID (MSc)

June, 2016

ARBA MINCH, ETHIO

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Table of Contents
ACKNOWLEDGMENT................................................................................................................................4
Abstract..........................................................................................................................................................5
ACRONYMS.................................................................................................................................................6
CHAPTER ONE............................................................................................................................................7
1. INTRODACTION....................................................................................................................................7
1.1 Background of the study......................................................................................................................7
1.2 statement of the problem......................................................................................................................8
1.3 Research question................................................................................................................................9
1.4 Objective of the study........................................................................................................................10
1.4.1 General objectives of the study.......................................................................................................10
1.4.2 specific objectives of the
study----------------------------------------------------------------------------------10

1.5 Significance of the study....................................................................................................................10

1.6 Scope of the study..............................................................................................................................10
1.7 Limitation of the study.......................................................................................................................11
1.8 Organization of the study...................................................................................................................11
Chapter Two.................................................................................................................................................12
2.1 Related Literature review.......................................................................................................................12
2.1.1Theoretical review...........................................................................................................................12
2.2.1 DEFINITION OF PROFIT.............................................................................................................14
2.2.2. ECONOMIC VERSUS ACCOUNTING......................................................................................14
2.3. FUNCTIONS AND SERVICES OF COMMERCIAL BANKS......................................................14
2.3.1. AGENCY SERVICE.....................................................................................................................15
2.3.2. GENERAL USABILITY SERVICES...........................................................................................15
2.4 MECHANISM OF CREDIT DEALING...........................................................................................16
2.5. MARKET COMPETITION AND THE CHALLENGES AHEAD.................................................16
2.6. PROFITABILITY RATIO................................................................................................................17
2.7.HOW IS PROFIT MEASURED?......................................................................................................17
2.7.1. GROSS PROFIT MARGIN...........................................................................................................18
2.7.2 PROFIT MARGIN..........................................................................................................................19

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RETURN ON INVESTMENT................................................................................................................19
2.8.1. RETURN ON EQUITY RATIOS.................................................................................................19
2.8.2.OPERATING INCOME RATIO....................................................................................................19
2.9.PROFIT PLANNING........................................................................................................................20
2.10.PROFIT MAXIMIZATION............................................................................................................20
2.10.1.OBJECTIVE OF PROFIT MAXIMIZATION.............................................................................21
CHAPTER THREE.....................................................................................................................................24
Research Methodology................................................................................................................................24
3.1 Research design.................................................................................................................................24
3.1.1 Source of data and data collection instrument................................................................................24
3.1.2.Population and sampling techniques...............................................................................................24
3.1.3 Sampling method............................................................................................................................24
3.1.4.Method of data analysis..................................................................................................................25
CHAPTER FOUR........................................................................................................................................26
4.1 Data Analysis and Interpretation.......................................................................................................26
4.1.1 Back ground information of the respondents..................................................................................26
4.1.2 Analysis by sex...............................................................................................................................26
4.1.3 Analysis by age group of respondents............................................................................................26
4.1.4 Analysis of respondents by educational level.................................................................................27
4.1.5 Analysis of respondents working experience in the banking industry...........................................27
4.1.6 Analysis of respondent responsibility of the bank..........................................................................28
4.2 FACTORS..........................................................................................................................................32
4.2.1.INTERNAL FACTORS..................................................................................................................33
4.2.2.EXTERNAL FACTORS................................................................................................................36
Chapter Five.................................................................................................................................................37
5. Conclusion and Recommendation...........................................................................................................37
5.1 Conclusion.........................................................................................................................................37
5.2 Recommendation...............................................................................................................................38
APPENDEX.............................................................................................................................................39
References................................................................................................................................................45

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DECLARATIOn

Statement of certification

This is to certify that Solomon Melkamu has carried out his research work. under my
supervision and advice and suggestion of my advisor Kedir Seid (Msc) and the guidance on
the topic entitled ‘factors affecting profitability of commercial bank of Ethiopia in Arba
minch branch.
The work is original in nature and it is suitable for submission for the award of BA Degree in
Accounting and Finance.

Advisor name KEDIR SEID(MS)

Signature ________________________________________

Date_______________________________________________

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ACKNOWLEDGMENT

First of all, I would like to thank my God for assistance and leadership in this difficult work.
Next to God I would like to thank my advisor Instructor Kedir Seid (Msc) for his tireless held
consultation and advices in perpetual assessment and consultation.
And finallyI would like to thank my family for their long last help.

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Abstract

Profit is a financial benefit that is realized when the amount of revenue gained from a business
activity exceeds the expense, cost and taxes need to sustain the activity. Any profit that is gained
goes to the business owners, who may or may not decide to spend it on the business. Profit is the
money a business makes after accounting for all the expenses. Regardless of whether the
business is running lemonade stand or public traded multinational company, consistently
earning profit is every company’s goal This study under the title assessment on factor affecting
the profitability of commercial bank of Ethiopia ArbaMinch branch in ArbaMinch town would
has want to know factors that affected the profitability of the bank. The general objective of the
study would assess and investigate the main factors that would affect the bank’s profitability.
There also specific objective in the study would mention. Both primary and secondary data
would conduct primary data collected though questionnaire secondary data collected from the
allowable literature on the subject and from published and un published materials. The data
analyzed by using both qualitative and quantitative data analysis particularly descriptive types
of analysis has be used in the study is percentage, and tables. A purposive sampling technique
has been used as sampling techniques to select sample from banks which are employees and
selected 20 persons from 63 employees as indicated in methodology and the obtained results
would analyze using descriptive analyzing method. Finally based on the result of findings,
conclusion and recommendations would forward problems which affect banks profit, understand
and evaluate which affect banks profit and give directions and encouragement of the institution
respectively.

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ABRIVATION
CBE:-commercial bank of Ethiopia

CBITDA:- companies before interest tax and depreciation and amortization

EBIT:- earnings before interest and tax

EBDIT:-earnings before depreciation, interest and tax

GAAP:- generally accepted accounting principles

GDP:-gross domestic product

NI:- net income

NOPAT:-net operating profit after tax

NPL:- non-performing loan

PAT:-profit after tax

PBT:- profit before tax

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CHAPTER ONE
INTRODACTION

1.1. Background of the study

Profit is a financial benefit that is realized when the amount of revenue gained from a business
activity exceeds the expense, cost and taxes need to sustain the activity. Any profit that is gained
goes to the business owners, who may or may not decide to spend it on the business. Profit is the

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money a business makes after accounting for all the expenses. Regardless of whether the
business is running lemonade stand or public traded multinational company, consistently earning
profit is every company’s goal (VonMises, 1951).

Banks mobilize, allocate and invest the greatest part of the economic agent savings. Accordingly,
their performance has substantial consequences on capital allocation, firm expansion, industrial
growth and economic development. Therefore efficiency and profitability of banks of interest not
just at the individual bank level, but also important at a broader macroeconomic level (Aremu
and Mejab, 2013).

Profitability of banks and other financial institution is affected by different factors such as,
lending policy, loan advancing procedure and practice customer management, interest rate
factors, performance of employees, competitors action, employees training, supervision over the
employees.In order to eradicate such factors that can affect the profitability of the bank, the bank
must give its care and attention on the overall activities and performance of both internal and
external environment. (Athan, 2006)

Strong and hard work the bank can minimize and avoid these factors by making them sound in
the operation. So that the banks must be always be aware of the things or factors those are going
to affect the profitability to the normal and profitability operation.The higher the banks give
focus on the future outcome of the current activities, the most favorable and optimum profitable
the bank could be and vice versa. If the bank is working hard the profitability is obvious. The
better profitability of the banks depending on the activities and performance do by the bank
particularly on the assessment and investigation of the bank to find out the optimum
solution.Therefore, all banks must be aware on the factors affecting the profitability, growth,
expansion and sustainability. The negligence and awareness problem causes total fall down of
not only the bank but also all financial institutions (Ibid, 2006).

In Ethiopia, commercial banks play an important primary role as financial intermediaries in the
economic growth process, channeling funds from savers to borrowers for investment. As
financial intermediaries, banks play an important role in the operation of an economy. In such
away, commercial banks are key providers of funds and their stability is of paramount
importance to the financial system. As such an understanding of determinants of their

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profitability and the derivers of bank profitability for that matter is essential and crucial to the
stability of economy (Aburime, 2008).

Therefore, this study aimed to assess the factors affecting the profitability of Commercial Bank
of Ethiopia (CBE), Arbaminchbrabch.

1.2. Statement of the problem

The current economic crisis has highlighted that a well-functioning financial system is
significantly important for economic growth. The financial system enables an economy to be
more productive as it allows investors with few resources to use saving from those with few
prospects of investing. In this context it is crucial to know what drives bank profitability. Higher
profitability not only allows banks to generate funds to grant more credit to the economy, but
also important for regulators as it guarantees more flexible capital ratios, even in a riskier
business environment. In addition, bank profitability must also lead to fair return for its
shareholders. There were so many factors that could affect profitability of the banks, financial
institution and business enterprises. Identifying those factors has great significance for the
successful operation the organization, because these factors were a means of measuring the
weakness and strengthens and to realize the changing business environment. (Gelos, 2006)

The main factors that affect profitability of the banks were highly related to the emergence of
new potential competitors in the market. In addition to this efficiency of banking services to
customers like money transfer, loan facilities, deposit services in comparison to other
competitors are the other factors(Hasichim, 2007).

Therefore, this study seeks to fill the gap which is not fulfill factors affect bank’s profit before
and recent time, so by providing full information above the factors that affect profitability by
examining the untouched one before done at the same issue, and examining factors affecting
profitability of commercial bank of Ethiopia in Arba Minch branch. The result of this study
shows the bank’s profitability remove those influenced factors.

Commercial bank of Ethiopia is large business institutions, so it provides many services to the
customer in order to facilitate customers need and to improve their profit, but some type of
services affecting banks profit.

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1.3. Researchquestion
In this study the researcher attempted to find out answerfor the following questions.

 What are the problems in the bank relation with profit?

 Is the bank well aware of those factors affecting its profitability?
 Was the bank giving services needed and contribute for the profitability?
 What were the main factors affecting the profitability of the bank?

1.4 Objective of the study

1.4.1 General objective

The general objective of this study was to assess factor affecting the profitability of commercial
bank of Ethiopia, Arba Minch branch.

1.4.2 Specific objectives

The specificobjectives of this study were:-

1. To identify the problems aroused in the bank in relation with profit.

2. To investigate whether the bank is well aware of those factors affects its profitability.

3. To evaluate whether the bank give services needed and contribute for the profitability.
4. To evaluate the method that through which the bank control the effect of competitors.

1.5 Significance of the study

The significance of this study included the following:-
 It enables policy makers and management body of the commercial banks to adjust
the bank management system and mechanisms.
 Suggest or propose solution for identified problem based on the gathered
information.
 Will provide information to managers about the customers feeling or preference
towards the bank services.
 Create awareness for customers, managers and others.

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1.6 Scope of the study

The conceptual border of this study focused on the assessment of those factors affecting the
profitability of commercial bank of Ethiopia,Whereas the geographical limit of the study is in
Arba Minchbranch.

1.7 Limitation of the study

In conducting this paper the researcher may face the following limitation:
I. Unwillingness of the respondents in providing me with the relevant data and
information.
II. Unwillingness of the respondents to answer the open-ended questionnaires.
III. Lack of experience on conducting research on the side of researcher.

1.8 Research Methodology

1.8.1 Research design
The design of this study was descriptive type, because the research would deal with those factors
affecting the profitability of the bank by gathering data from different sources. The researcher
would use mixed research approach which is qualitative and quantitative to collect, describe and
analyze the data to solve bank’s business problem. The reason for using quantitative approach is
to be address the research question and design of study that involve collecting a quantitative
method. The reason for using qualitative is to address the research question and design for
ollecting and analyzing the qualitative data using interpretative.

1.8.2. Source of data and data collection instrument

The researcher used both primary and secondary data sources to gather the required data. The
primary data was collected through questionnaire. The questionnaire includes both close-ended
and open-ended questions, whereas secondary data was gathered from different sources such as
banks document, magazines, internet and previous researches done on the same issue.

1.8.3. Population and sampling techniques

The total population of the study was 63 employees; from this the researcher selected a sample to
gather the relevant data, by using purposive sampling method. That means 20 persons as a
sample. The reason of using this sampling technique is the data which is needed to control the
problem can only obtained from those people.

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1.8.4. Method of data analysis

After data has been collect and it processed using the basic data processing techniques such as;
editing, coding and classification. The data collected from both primary and secondary data
sources and analyzed using descriptive analysis and appropriate interpreting conclusion and
recommendations are forward base on the result. So the data would be analyzed and presented by
using tables, charts and diagrams which showed qualitative and quantitative data, to make data
more suitable for interpretation

1.9 Organization of the study

This study has four chapters. The first chapter dealt with introduction including back ground
of the study, statement of the problem, objectives of the study, significance of the study,
scope of the study, limitation of the study, and organization of the study. The second chapter
related review literature, the third chapter includes research methodology, the fourth chapter
was data presentation, analysis and discussion and the fifth chapter was conclusion and
recommendation.

Chapter Two
Related Literature review
2.1. Theoretical review

2.2.1 DEFINITION OF PROFIT

2.2.2. ECONOMIC VERSUS ACCOUNTING

The measurement of profit is one of the difficult problems faced by the accounting professions.
Accountant’s concept of profit differs from that of the economists. The figure of accounting
profit is the result of the application of generally accepted accounting principles (GAAP). The
accountant has to use his judgment, which at times is based on arbitrary assumptions for
measured profit. The recognition of revenue and expenses during the accounting period poses a
basic measurement problem. Most firms use accrual concept to allocate receipts and
expenditures to accounting periods as revenue and expenses. For example, a transaction is

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treated as sale and recorded as revenue when title to goods is transferred to the buyer,
irrespective of the period in which cash is received. Similarly expense is recognized is the period
in which it is incurred, not when cash is paid.

The accounting profit is also distorted because of the optional ways of treating depreciation,
research and development expenditure, good will and patents and inventory valuation. The price
level changes further complicate the measurement of profit because of inflation, the firm. During
inflation profits are earned on inventories held by the firm and depreciation allowance based on
historical cost fails to maintain the firm’s earned power.

In economic sense, profit would mean net increase in the wealth, visitors, cash flow plus change
is the value of the firm’s assets. This definition incorporates the time dimension and therefore,
implies the discounted definition of profit is based on accrual principle and includes non-cash
items. Even if we assume that all items of revenue and expense are on cash basis still these
would be difference b/n accounting profit and cash profit; the accountant charges depreciation,
which is a non cash items, to compute accounting profit. Thus, the operating cash flow (i.e. cash
from operations) or cash profit can be found out by adding depreciation to the accounting profit.
The total cash flow of the firm however is also affected by the balance sheet changes.

This section reviews the basic theoretical issues related to banks and bank profitability and its
determinants. It presents the bank’s profitability theories and factors influencing bank
profitability.

The role of bank’s

This paragraph discusses the role of banks in the economy and examines the question, why bank
exist. At first sight the answer to this question is very intuitive and simple, banks act as
intermediary between those who are in need for money and those who have excess of money.
Looking more closely to this question there could be a more detailed explanation namely; entities
can borrow and save directly through their capital market. Further more capital markets suffer
from the information asymmetry and the agency problem. The agency problem refers to the
dissimilar incentives of borrowers and savers, in a broader context; it refers to the dissimilar
incentives of principles and agents.

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Another important aspect of banking is the function of maturity transformation. Banks receive
short term savings from depositors and transform those saving in to long term loans to
borrowers.

A. Theories of bank profitability

Studies on the performance of banks started in the late 1970s/1980s with the application of two
industrial organizations modal ; the market power and efficiency structure theories and the
balanced portfolio theory has also added greater insight in to the study of bank profitability.
Each of the mentioned theories and other related to bank profitability and its determinants are
discussed in detail in this particular as follows:(Athanasoglu et al,2006).

The performance of bank is influenced by the market structure of the industry. Thereare two
distinct approaches within the market power theory, the structure conduct performance (SC P)
and the relative market power (RMP) hypothesis. According to the SCP approach, the level of
concentration in the banking market gives rise to potential market power by banks, which may
raise their profitability. In the RMP approach banks profitability is influenced by market share. It
assumes that only large banks with differentiated products can influence prices and increase
profits.

B. The Efficiency Theory

The efficiency hypothesis, on other hand posit that bank earn high profit, because they are
more efficient than others. There are also two distinct approaches within the efficiency, the
X- efficiency, and scale efficiency hypothesis. According to the X-efficiency approaches
more efficient firms are more profitable because of their lower costs. The scale approach
emphasizes an economy of scale rather than differences in management of production
technology.(Athanasoglu et al 2006).

C. Balanced portfolio theory

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The portfolio theory approach is the most relevant and places an important role in the bank
performance. According to the portfolio balance model of asset diversification the optimum
holding of each asset in a wealth holder. Portfolio is a function policy decisions of determined by
a number of factors, such as the vector of rates of return on all assets held in portfolio, a vector of
risks associated with si

2.3. FUNCTIONS AND SERVICES OF COMMERCIAL BANKS

The main function of commercial banks are borrowing and lending of money. They borrow
money by taking all kinds of deposits. Deposits may be received on current account where by
the banker incurs the obligators of paying tender after expire of a fixed period, or on deposit
account where by the banker under takes to pay the customer an agreed rate of him an agreed
period of notice for withdrawals. Thus, a commercial banker whether it be through current
account society. Then be provides this money to those who are or by discounting bulls of
exchange or promissory notes. Thus a primary function or a commercial banker is that of banker
and a dealer in money to those who are in need of it by granting over draft or fixed loans or by
discounting bulls of exchange or promissory notes of banker and dealer in money. By
discharging this function efficiently, a commercial bank renders very variable service to the
community by increasing the productive capacity of the country and there by accelerating the
pace of economic development.

Thus we have seen that a banker receives deposits which he has to repay according to his
promises and makes them available to those people who are really in need of them. (Shekhar and
Shehar 18th edition)

ze of portfolio.(Nzongang and athemnkeng ,2006

2.3.1. AGENCY SERVICE

Most of the commercial banks have an executor and trustee department; some many have
affiliated companies to deal with this branch of their business they aim is to provide, therefore, a
complete range of trustily executor or advisory services for a small change. The business of
banks acting as trustees, administrator, etc…, has continuously expanded with considerable use
fullness of their customers.

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Private companies wishing to set up pension funds may appoint a bank as custodian trustee and
investment adviser, while retaining the administration of the scheme in the hands of the
management of the fund.

Most banks will undertake on behalf of these customers the preparation of income tax returns
and claims for the recovery of overpaid tax.

2.3.2. GENERAL USABILITY SERVICES

These services are those in which the banker’s position is not that an agent for his customer they
include the issue of credit instruments like letter of credit and travelers’ check, the acceptance of
bills of exchange, the safe custody of valuables and documents, the transaction of foreign
exchange business, acting as referred as to the responsibility and financial standing of customers
and providing specialized advisory service to customers.

By selling drafts or orders and by issuing letter of credit circular notes, traveler’scheque, etc… a
commercial banker is discharging a very important function.

2.4 MECHANISM OF CREDIT DEALING

Banks always try to minimize their holding of idle cash to the lowest extent possible. In their
attempt to achieve this end, they unwittingly increase the total amount of money in circulation in
the community. It does not mean that they increase the total amount of legal tender currency.

2.5. MARKET COMPETITION AND THE CHALLENGES AHEAD

It is clear and being increasingly realized by many bankers that banking is no more a deposit
taking and money lending institution, making profits on the deferential, not is it an institution
which could be run by bankers whose only qualifications were high integrity, intuitive
shrewdness, certain degree of impassivity, but not necessarily high intellect.

The banking industry is an increasingly competitive environment would face new challenges and
support unities.

It is time for them now to be proactive in their approach and to anticipate the new demands on
their skills that will be emerging and to prepare for the same through appropriate adjustments in
their organizational structure and method of operations and procedures in an environment of
operational flexibility and internal autonomy.

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As competition and diversification exposes banks to new risks, sound bank management
becomes a pre condition in the new area of financing liberalization. Thus there arise a need for
building strong management which is responsive to change policy reform in the finical sector can
be introduced on a durable basis only through concrete efforts, to strengthen institutional frame
work in which banks operate and develop the necessary know how and human capital. (Michael
E. Baker, 1998)

Banks do need a considerable degree of autonomy banks do need a considerable degree of

autonomy so as to be able to clearly define this operating role and strategy and perform their
banking business in a professional manner. Autonomy must also extend to the banks policies
relating to lending, financial management, and personnel.

2.7. HOW IS PROFIT MEASURED?

Profit can be measured in various ways. Gross profit /GP/ is the difference between sales
and the manufacturing cost of goods sold. A number of companies in India define gross profit
differently. They define it was earnings profit before depreciation, interest and taxes /PBDIT or
EBDIT/.

A number of multinational companies interests tax and or earnings measure as earnings before
interest’s tax and depreciation and amortization or CBITDA. The most common measure of
profit is profit after tax /PAT/, or net income (NI), which is a result of the impact of all factors on
the firm’s earnings. Taxes are not controllable by management. To separate the influence of
taxes, therefore, profit before taxes (PBT) may be computed. If the firms profit has to be
examined from the point of view of all investors /lenders and owners/ the appropriate measure of
profit is operating profit, operating profit is equivalent of earnings before interest and taxes
(EBIT). This measure of profit shows earning arising directly from the commercial operations of
the business without the effect of financing. The concept of EBIT may be broadened to include
non-operating income is they exist. On an after tax basis, profit to investors is equal to EBIT (1-
T), where T is the corporate tax rate. This profit measure is called net operating profit after tax or
NOPAT.

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As profitability measurement is the guide to effective management accountants will frequently

be expected to produce statement of problem to measure profitability.

There are six measurement being as follows

1. Comparison of total or unit profit

2. Percentage profit related to sale
3. Percentage profit related to time factor
4. Discounted cash flow
5. Profit related to time factor
6. Payback period.
Profitability in important when budgeting the level of activity at which the money factoring unit
is to be operated the ratio of profit to amount of capital employed should be uncertain a share
holder in the company or owner of a business can reasonable except return capital invested for
two basic reason.

1. Payment for the use of other capital

2. Payment for the risk takers in investing his capital.
Creditors will stay away from companied with profitability since the amount used to them may
not be paid absolute collect profit by itself has the significance unless it is related to its source
same major ratios that measure operating result are summarized as follows.

2.6. PROFITABILITY RATIO

A company should earn profits to service and grow over a long period of time. Profits are
essential, but it would be wrong to assume that even action initiated by management of a
company should be aimed at maximizing profit, irrespective of concerns for customers,
employees, suppliers or social consequences. It is unfortunate that the word “profit” is looked
upon as a term of abuse since some firms always want to maximize profits at the cost of
employees, customers and society.

Profit is different between revenue and expenses over a period of time (usually one year), profit
is the ultimate “output” of a company and it will have no future it if fails to make sufficient
profit. Therefore, the financial manager should continuously evaluate the efficiency of the
company is terms of profits. The profitability ratios are calculated to measure the operating

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efficiency of the company. Besides management of the company, creditors and owners are also
interested in the profitability of the firm. Creditors want to get interest and repayment of
principal regularly owners want to get a required rate of return on their investment. This is
possible only when the company earns enough profits.

Generally, two major types of profitability ratio are calculated:-

 Profitability in relation to solutions

 Profitability in relation to investment

2.7.1. GROSS PROFIT MARGIN

The gross profit margin the percentage of each birr left over of business has paid for its grades
the highest he gross profit earned the better profit equals net sales less cost of goods sold.

2.7.2 PROFIT MARGIN

The ratio of net income for net sale is called the profit margin it indicate the profit generated
revenue and is an important measures of operating performance. It provides clause and
companies preparing cost structure and production.

Profit Margin = Net Income

Net Sales

RETURN ON INVESTMENT
Return an investment shown the extent to which earning achieved on the investment made is the
business. There are basically two ratios that evaluate return on investment one is return an asset
directs the efficiency which were management has its available resource to generate income
return as asset can be raised by increasing other the profit margin or the asset turn over. However
profit margin many industry since it subject to sales cost control and pricing.

2.8.1. RETURN ON EQUITY RATIOS

Measurement to the profit earned by the firm through the use of capital supplied by stock holder

Return on equity ratios = Net income

Average equity

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2.8.2. OPERATING INCOME RATIO

Measurement of the profitability and business operation in relation to sales here expense.
Revenue gains and loss as that are unrelated to used operation are excluded.

Operating income ratio = Operating ratio

Net sales

The net profit percentage sale = Net income

Net sales

Profit has been normally regarded as the wages paid to the entrepreneur as the rent paid to the
employees specialist knowledge by the entrepreneurs as the interest on the entrepreneur capital
as it compares for risk taking as payment for management skill and as surplus expropriated by
capitalist from worked profit is the amount of money a company has left over from the sale of its
product it has paid for all the expense of the production. This expenses includes it has paid for all
the expense of production goods and services were saving price is greater than cost of producing
them. Thus search for profits is also the search use of countries labor and raw materials that will
satisfy consumer most completely some business execute constantly lower price to captures sales
and profit from these all interest taxes and changes against the gross profit have been paid profit
is amount of money of company has left over from the sale of production. These expenses of
production include loss of raw materials, workers and advertisement service charged and etc.

2.9. PROFIT PLANNING

The function of the financial manager may be broadened to include profit planning function.
Profit planning refers to the operating decisions in the areas of pricing costs, volume of output
and the firm’s selection of product lines.

Profit planning is, therefore, a prerequisite for optimizing investment and financial decision. The
cost of structure of the firms i.e. the mix of fixed and variable costs has a significant influence on
a firm’s profitability, fixed costs remains constant while variable costs change in direct
proportion to volume changes because of the fixed costs, profits fluctuate at a higher degree than
the fluctuations in sales. There is a charge in profits due to charge as operating leverage. Profit

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planning helps to anticipate the relationship between volume, costs and profits and develop
action plans to face unexpected surprises.

2.10. PROFIT MAXIMIZATION

Firm’s producing goods and services may fluctuation is a market economy or in a government
controlled economy. In a market economic, prices of goods and services are determined in
competitive markets; firms in the market economy are expected to produce goods and services
designed by society as efficiently as possible.

Price system is the most important organs of a market economy indicated was goods and services
society wants good of services is great demand command higher prices.

This return is higher profit for firms more of such goods and services are produced higher profit
opportunities attract other firms to produce such goods and services. Ultimately, with
intensifying competition an equilibrium price is reaches at which demand and supply match. In
the case of goods and services, which are not required by society, their prices and profits fail.
Producers drop such goods and services in favor of more profit opportunity. Price system directs
managerial efforts towards more profitable goods at services. Price is determined by the demand
and supply condition as well as the competitive forces and they guide the allocation of resource
for various productive activities.

A legitimate question may be raised would the price system is a free market economy serve the
interest of the society; Aden Smith has given the answer many years ago. According to him, by
directing industry in such a manner as its product may be of greater value intends only his own
gain, and he is in this, as in many other cases, lend by an invisible hand to promote and end
which was not part of his intention. Pursuing his own interest he frequently promotes that of
society more effectively than he really intends to promote it.

Following Smith’s logic it is generally held by economists that under the condition of free
competition businessman pursuing their own self-interest also serve the interest of society. It’s
also assumed that were individual firms perusing the interest of maximizing profits. Society’s
resource is efficiently utilized.

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In the economy theory, the behavior of a firm is analyzed in terms of profit maximization. Profit
maximization implies that a firm either produces maximum output for a given amount of input or
uses minimum input for producing a given output. The underlying logic of profit maximization
causes the efficiency allocation of resource. Under the competitive market condition and profit is
considered as the most appropriate measure of a firm’s performance.

2.10.1. OBJECTIVE OF PROFIT MAXIMIZATION

The profit maximization assumes perfect completion and is the force of imperfect modern
market it cannot be a legitimate objective of the firm. It’s also argued that profit maximization as
a business objective developed in the early 19th century when the characteristics features of the
business structure were self-financing private properly and single entrepreneurship.

The only aim of the single owner than was to enhance his or her individual wealth and personal
power which could easily is satisfied by the profit maximization objective. The modern business
environment is characterized by limited liability and advice between management and owner
ship, share holders and lenders today finances the business firm but it’s controlled and directed
by professional management. The other important stakeholder of the firm is customer,
employee’s government and society is practice the objective of those stakeholder or constituents
of a firm differ and may conflict with each other. The manager of the firm has the difficult task
of reconciling and balancing this conflict objective. In the new business environment, profit
maximization is regarded as unrealistic difficult, in appropriate and immoral.

It is also feared that profit maximization behavior is market economy may tend to produce good
and service that wasteful and unnecessary from the society’s point of view also. It might lead to
inequality of income and wealth, it is for this reason that governments tend to intervene in
business price system and therefore, the profit maximization principle may not work due
imperfections in practice.

Oligopolies and monopolies are quite common, phenomena of modern economics, firms
producing some good of service differ substantially in terms of technology, costs and capital in
view such conditions it is difficult to have a truly competitive price system and thus it is doubtful

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if the profit maximization behavior will least the optimum social welfare. However it is not clear
that abandoning profit maximization as a decision criteria’s would solve the problem rather
government intervention may be sought to correct market imperfection and to promote
competition alone business firms.

A market economy, characterized by a high degree of competition would certainly entre efficient
production of goods and services desired by society in profit maximization operationally feasible
criteria’s. A part from the aforesaid objections, profit maximization fails to serve as an
operational criteria’s for maximizing the owners economic welfare. It fails to provide an
operationally feasible measure for ranking alternative course of action in terms of their economic
efficiency. It suffers from the following limitations.

- It is vague
- It ignores the timing of returns
- It ignores risk
(Sources financial management)

Determinants of profitability; an empirical study on commercial bank of Ethiopia is outcome of

many factors mentioned above in the study, and additional the researcher want to investigate to
solve unsolved problems in the studied organization. If the researcher studies compliance with
the accepted standards with respect to original and quality.

The results of this study shows the bank’s profitability removed those influenced factors before
the empirically suggested that, capital, labor productivity growth, inflation significantly affect
profitability. All the bank specific determinant variables statistically impact on bank profitability.

During the period under this study try to remove negative impact on banks profitability and to
encourage a positive impact like non-interest income and capitalization. Empirically suggested
that commercial bank of Ethiopia becomes more profitable than their competitors. They become
better capitalized banks, a relatively large share of deposits and more profitable.

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CHAPTER THREE
DATA ANALYSIS AND INTERPRETATION

This chapter deals with the interpretation and analysis of data gathered through primary sources
to assess the actual situation sufficient and relevant information for the topic under the study was
collected. While 20 questionnaires have been prepared and 100% collected. Accordingly the
analysis is based on the collected data and conclusions have been made for the total population.

3.1.1Back ground information of the respondents

Under this section, back ground information of respondents which included (Sex, age,
educational level, working experience in banking industry and responsibility in the bank).

Table 3.1.1 personal attributes of the respondents

Description Item No. of respondents percentage

Male 14 70%
Sex Female 6 30%
Total 20 100%
23-30 12 60%
31-40 5 25%
Age
Above 40 3 15%
Total 20 100%
diploma - -
First degree 16 80%
Educational level
masters 4 20%
Total 20 100%
Working experience Below 5 years 9 45%
in the banking 5-10 years 6 30%
industry 11-15 years 3 15%
Above 15 years 2 10%
Total 20 100%

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Manager 1 5%
Vice- manager 1 5%
Responsibility in the
Accountant 4 20%
bank
Loan service officer 2 10%
Customer service 12 60%
officer
Total 20 100%
Source:- primary data 2016

From the above table shown that 70% of the respondents are male and 30% are females. This
implies that even if female participation in the respondents of this questionnaire is lower than
that of males. This implies that backward attitude towards female caused the unbalanced
distribution of sex in the commercial bank of Ethiopia.

Regarding the age of respondents, from the total sample population 12(60%), 5(25%), 3(15%)
are within the group of 23-30, 31-40 and above 40 years respectively. The two age groups
highly engaged in the sector which covers 85% jointly. But the participants above 40 years are
relatively lower. This shows that low participants of above 40 years old.

As indicated the above table the total sample population of has two types educational level. As
shown above 16(80%) and 4(20%) and from those educational level the respondents of first
degree level professionals which cover largest percentage of respondents. With respect to
respondents about working experience of in banking industry the respondents large number of
employees found between below 5 years and 5-10 years working experience. This shows most
employers in the bank below 5 years – 10 years experienced employers and between 11-15 years
and above 15 years employers lower working experience in the banking industry.

As shown the above table 12(60%) respondents in the bank is customer service officer. This
clearly shows most employees in the bank customer service render and from this researcher can
observe that the number of manager and vice manager is limited.

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3.1.2 Analysis of the type of deposit bank accepts from customer

Which kind of deposit Respondents response No. of respondents Percentage

does the bank accepts Time deposit - -
from customer Demand deposit - -
Both time and 20 100%
demand deposit
Total 20 100%
Source: primary data 2016

As shown the above table 100% of respondents accept both types of deposits from the customer.
They permit demand depositors as well as time depositors as they want to deposit their money in
the bank. That means bank takes time deposit from the depositors to provide money to the
borrowers, in order to get interest to improve their revenue and they takes demand deposit from
depositors to give services as any time they want.

Table 3 .1.3 Analysis of banks revenue from money transfer, safe custody and other
services

Descriptive Respondents No. of respondents Percentage

Response
Does the bank earn sufficient revenue Yes 6 30%
from money transfer, safe custody No 14 70%
and other services Total 20 100%
Source: primary data, 2016

From the above table 70% respondents replied that the bank is not earning sufficient revenue.

Then the researcher asked the reason of the bank why not earn sufficient revenue and the
respondent answered that sometime the external influences affects the banks revenues through
the bank is working hard.

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The researcher asked the respondents the type of loan gives the bank and the respondents
answered as follows:

Table:-3.1.4 Analysis of interest rate from type of loan.

Descriptive Respondents response Number of respondents Percentage

Type of loan the bank Long term loan 20 100%
earns higher interest Short term loan - _
rate
Total 20 100%
Source; primary data, 2016

From the above table 100% of respondents replied the bank gets higher interest rate from long
term loan.

Table:- 3.1.5. Analysis of repayment of bank its depositors except time deposit

Descriptive Respondents response Number of respondents Percentage

Does the bank replay Yes 4 20%
its depositors
No 16 80%
whenever they need
except for time
deposit.
Total 20 100%
Source; primary data, 2016

From the above table 80% respondents replied that the bank is unable to pay back them,
whenever they need to reacquire back except for time deposit and a few number of respondents
answered that does the bank repay money to the depositors.

Then the researcher asked the respondent to know the reason why the bank is not pay back
except for time deposit and the respondent answered as follows.

Table:- 3.1.6 analysis of bank doesn’t repay money to the depositors

Descriptive Respondents response No. of respondents Percentage

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Problem in financial
What is the reason
liquidity(may be in 13 65%
bank doesn’t repay
money to depositors kind)
Problem in payment 5 25%
ability of creditors
Both of them 2 10%
Total 20 100%
Source: primary data 2016

Most of the respondents answered that the problems of financial liquidity to pay back money to
the depositors and some respondents replied that problem in payment ability of creditors, so
researcher decides that problem in financial liquidity according to the percentage of the
respondents.

The researcher asked the respondents to know the effects of deposit on profitability and the
respondents answered as follows.

 According to commercial bank of Ethiopia deposit is expectation of significant

impact on profitability.
 It is positive effect on profit as well as safety of money.

Table:- 3.1.7. Analysis of the bank collect amount of loan.

Descriptive Respondents response Number of respondents Percentage

Does the bank always Yes 5 25%
collect full amount of No 15 75%
loan from its debtors.

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Total 20 100%
Source; primary data, 2016

From the above table 75% respondents answered that the bank is not collecting the loans with
full amount of loan from debtors. The researcher asked the respondents to know the reason why
not collect full amount of loan from debtors, and the respondent answer that there is so many
different reason to collect full amount of loan such as borrowers are dishonest, borrowers are not
able to pay and others.

Table:-3.1.8. Analysis of banks profit

Descriptive Respondents response Number of Percentage

response
Do you think that the Yes 8 40%
bank is profitable? No 12 60%
Total 20 100%

Source; primary data, 2016

From the above table 60% respondents replied that bank is not profitable and the remaining 40%
of respondents replied that bank is profitable. The majority of respondents answered that bank is
not profitable.

Table:-3.1.9 Researcher asked the reason why the bank is not profitable

Descriptive Number of respondent Percentage

Bankruptcy
Lower rate of return
Increasing cost return of debit
Neutrality of profit and loss
They give more attention for 5
public services rather than
banks profit
Total
Source; primary data, 2016
- -
6 30%
8 40%
1 5%
25%
20 100%

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As shown the above table 40% respondents replied that increasing cost return of debit and 30%
and25% respondents replied lower rate of return and they give more attention for public services
rather than their profit respectively. Only 5% respondent replied the neutrality of profit and loss
and no one replied on the bankruptcy.

The researcher asked the respondent for the above question any to know the action that the bank
to solve those problems aroused in the bank and respondent answered as follows

Table:- 3. 1.10 Analysis of bank takes action to return their money from borrowers.

Descriptive Respondents response No. of respondents Percentage

We study about the 2 10%
issue
What action bank We don’t take any 10 50%
took return their action
money We plan to take action 8 40%
Others - -
Total 20 100%

The bank still does not take any action but yet the bank is going to take the appropriate action
and decision as well as alternatives. And a few number of respondents said they studies about the
issue.

Table:- 3.1.11 Analysis effects of the competition on market share and profitability.

Descriptive Respondents response Number of Percentage

respondents
Are there any effects Yes 13 65%
of competition on No 7 35%
banks market share
and profitability

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Total 20 100%
Source; primary data, 2016

From the above table 65% respondents replied that there is effects of competition on banks
market share and profitability and the researcher asked the effects and influence and respondents
answered that as the number of competitors increase in the financial market, the bank increases
the cost to win those competitors, and the researcher again asked the respondents to know the
techniques the bank control the effects of competitors and the respondents response is by
delivering the best service to the customers.

Table:-3.1. 12, this analysis is banks awareness about profitability.

Descriptive Respondents Number of Percentage

response respondents
Is the bank well Yes 7 35%
aware of those
No 13 65%
factors that affect
Total 20 100%
its profitability

Source; primary data,2016.

From 100% of respondents 65% answered that the bank is not well aware of those factors that
affect its profitability. The researcher asked the respondents the reason why the bank not well
aware of those factors that affect profitability and respondents replied that bank knows some
factors that affect the profit of the banks, however in unknown problem would come and affect
the bank’s profitability.

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CHAPTER FOUR
4.1 Conclusion and Recommendation

The bank takes demand deposit, time deposit and other type of deposit and they were unable to
pay back to the depositors whenever they need to reacquire back, because they have a reason
which is financial liquidity as well as not properly recovering the loans from the borrowers to
pay those who deposited their money in the bank. The bank is not earning sufficient revenue,
because sometimes externally influences affect the bank’s profitability while bank is working
hard, mostly the banks work is leading they provide both long term and short term loan, in order
to get high interest rate, however they get high interest rate only from long term loan. And
another factor is in the bank is not recovering the loans with full amount without default debtors.

There are so many problems aroused in the bank relation with profit, the problem is aroused in
the bank is low rate of return and increasing cost in the bank. Then the bank eradicate this
problem design to take action but bank still does not take any action yet the bank is going to take
the appropriate action and decision as well as alternative. Another problem also influenced banks
profit which is effects of banks market shares and profitability, which is effects and influenced of
competitors in case of effects and influences of competitors at the number of competitors
increases in the financial market, then the bank increases the cost to win those competitors and
using techniques to win them by delivering the best service to the customers. In the case of
awareness the bank is not well aware of those factors that affect its profitability the reason for
bank is not well aware of those factors that affect the profit of the bank which is bank knows
some factor that affect their profit, in unknown problem would come and affect the bank’s
profitability.

4.2 Recommendation

In light of finding of the study the following recommendation were formulated.

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- The bank is should always try and recover the loans with full amount without
default of debtors.
- The bank should always be able to pay back the depositors whenever the need
to reacquire back except for time deposit.
- There bank should solve financial liquidity problem.
- The bank should properly recover the loans from the borrowers to pay those
who deposited their money in the bank.
- Besides to customers’ satisfaction, the bank should earning sufficient revenue.
- In order to prevent those external influences, the bank should always use
different mechanisms.
- As much as possible the bank should give due attention on profit because, the
life of bank depends on the profit earned.
- The return from all investments should always cover the banks cost incurred
to win competitors.
- There should not be delay in bank to decide on the operation and profit related
issues.
- Since the banks life is its profit, the bank should be well aware of those factors
that affect its profitability.
- Regardless of the nature and type of factors that affect the profit of the bank,
should whenever detect, prevent and protect them.
- By using systematic and tactic full ways, the competitors should not take the
advantage of commercial bank of Ethiopia.
- By using the plan which to take action is good for return the bank’s money
from borrowers.
- The bank giving both short term and long term loan to the customer is good
service to improve banks profit as well as to fulfill the borrower’s interest.

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APPENDEX

ARBAMINCH UNIVERSITY

COLLEGE OF BUSINESS AND ECONOMICS

DEPARTMENT OF ACCOUNTING AND FINANCE

QUESTIONNARE PREPARED FOR BOTH MANAGER AND EMPLOYEES OF

COMMERCIAL BANK OF ETHIOPIA IN ARBAMINCH BRANCH.

Dear Respondent:

This questionnaire is prepared by third year accounting and finance student to gather
primary data for the study entitled “Factors affecting the profitability of commercial
banks of Ethiopia, Arba Minch branch” which is conducted for the partial fulfillment of
the researcher’s B.A. Degree in Accounting and finance. Since the findings of this study
highly depends on your genuine response the researcher kindly request you to fill the
questionnaire with due care. Finally, the researcher would like to assure that the result of
your response will be kept secret and used only for academic purpose.

THANK YOU IN ADVANCE!

Instructions:

No need of writing name.

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Indicate your answer by Putting “X” sign on the boxes in front of each item and fill the
relevant information as well.
You can select more than one item for a single question as appropriate.

Part- I: Personal information of respondents

1. Sex:
A. Male
B. Female
2. Age

A. 23-30
B. 30-40
C. Above 40 years
3. Educational level:
A. Diploma
B. First degree
C. Masters
D. Other
4. Working experience in the banking industry?
A. Below 5 years
B. 5 – 10 years
C. Between 10-15 years
D. Above 15 years
5. Responsibility in the bank
A. Manager
B. Vice manager
C. Accountant
D. Loan service officer
E. Maker/customer service officer
F. Other

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Part- II: Research related Questions

1. Which kind of deposit does the bank accepts from customers?

A, demand deposit B, time deposit C, others
2. Does the bank repay its depositors whenever they need except for time deposit?

A, yes B, no

3. If your answer No2 is “no” what do you think the reason?

A, problem in financial liquidity (may be in kind)
B, problem of payment ability of creditors
C, both of them
4. What is the effect of deposit on profitability?
____________________________________________________________
____________________________________________________________
5. Does the bank earn sufficient revenue from money transfer, safe custody and
other services?
A. Yes B. no
6. If your answer for the above question is no, why?

__________________________________________________________________

7. Which type loan does the bank to provide to its customers to improve their
profitability?
A. Long term loan B. short term loan C. both
8. Which type of loan the bank earns higher interest rate?
A, short term loan B. long term loan
9. Does the bank always collect full amount of loan from its debtors?
A, yes B, no
10. If your answer for question “9” is “no” what do you think is reason?
A. We don’t give attention to collect it from debtors
B. The borrowers are dishonest

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C. The borrowers are notable to repay

D. Bankers keep loan from debtor honestly
E. Others_____________________________________________
11. Do you think that the bank is profitable?
A, yes B, no
12. If your answer for NO 11 is “no” what do you think is the reason?
A, bankruptcy C, increasing cost return debit
B, lower rate of return D, neutrality of profit and loss
E, they give more attention for public services rather than their profit.
F, others _____________________________________
13. If your answer for the above question is any, what action you took?
A. We study about the issue
B. We don’t take any action
C. We plan to take action
D. Others _____________________________________
14. Are there any effects of competition on banks market share and profitability?
A, yes B, no
15. If your answer for the above question is yes, what are the effects?
__________________________________________________________________
_______________________________________________________________
16. If your answer question 14 is again yes, by what method the bank control the
effect of competitors?
__________________________________________________________________
___________________________________________________________
17. Is the bank well aware of those factors that affect its profitability?
A, yes B, no
18. If your answer for the above question is no, why?

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References

 Aburime, Tu (2008) banks profitability macro economic evidence from Nigeria

 Al-Haschim,( 2007) Determinants of commercial banks profitability in Sub-
Saharan Africa, IMF.
 Aremu and Mejab (2013) relation of bank and economy. University of Kuwait
Natal.
 Athanasoglou, P journal of international financial market, institution and
money.
 Gelos,(2006) Determinants of banks profit performance and spreads
International Monetary fund Working paper in Latin America Western
Hemisphere

 Von Mises,L (1951) . Economic Analysis of banks profit and loss. Austrian
Economists Foundation for Economic education.
 Michael E.Baker,(1998).studies the competition and diversification of bank,
Baker College center district of Colombia United Studies.
 Levine (2000) study on positive impact banks profitability.
 Nzongang and Athemnkeng (2006)
 Perry, P (1992) Do Banks gain and loss from inflation, Journal of retail Banking.

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