Santiago lbarreche is an Associate Professor of Information System in the Department of Management. College of Business Administration at The University of Texas at El Paso. Robert D. Tollen is an Associate Professor of Economics and Finance in the Departmcet of Economics and Finance. College of Business Administration at The University of Texas at El Paso

Ibarreche, Santiago

Tollen, Robert D.

English

Georgia Southern University: Digital Commons@Georgia Southern

Southern Business Review Volume 13 Issue 2 Article 6 September 1987 Stepwise Analysis of Bank Statements Santiago Ibarreche The University of Texas Robert D. Tollen The University of Texas Follow this and additional works at: https://digitalcommons.georgiasouthern.edu/sbr  Part of the Business Commons, and the Education Commons Recommended Citation Ibarreche, Santiago and Tollen, Robert D. (1987) "Stepwise Analysis of Bank Statements," Southern Business Review: Vol. 13: Iss. 2, Article 6. Available at: https://digitalcommons.georgiasouthern.edu/sbr/vol13/iss2/6 This article is brought to you for free and open access by the Journals at Digital Commons@Georgia Southern. It has been accepted for inclusion in Southern Business Review by an authorized administrator of Digital Commons@Georgia Southern. For more information, please contact digitalcommons@georgiasouthern.edu. TEPWI E LY I OF B 1.K T T MENT Sumiago lbarreche and RnhC'l'I D. Toi/en Introduction Trauitionally. commercial bank\ have been treateu a~ a unique ca~e for finan-cial analysis. The strucmre of b,mk finanrn1l statcmcnt, ant.I the nature of their deci,ion processes i~ believed different enough from the non-financial ,cctor to raise questions regarding applicability of ~tandard analytical tooh. The dramatic change~ in competitive environmem among financial intcrmcuiarie, !-.mce the Bank-ing Act of 1980 ha, !\erved only to emphasize the~c difference!. while providing. at the ,ame time. heightencJ awarcnc,, of the need for clear and ,implc tooh of analy,i~. MoM bu,incs, generated intormation is. of cour~e. compiled for internal u,e. Data made available to the public arc typi ally in the form of ba~ic linanc1al \tatement anuior finanL·ial ,ummaric,. It i accordingly C>\Cntial for the analy,t to have a ,ound under,tanding of each piece of in format inn in order to (facriminate relative to its quality and usefu lnes . In the ca,c of the non-financial corporation. a time ,erie~ analyst-'> using ,tandard ratio, provides a clear ha_.,,~ for interpreta-tion of behavior. Applied against industry norm,. the analyst can a,~e_.,_., the impact of managerial decision~ and J1aw conclusion, regarding their meril. The intent of thi paper i~ to pre_.,ent a methodolog) for the analy.,is of finan-cial intcrmediane, "hich offer. much of the clarity and ea-'>C currently extant in the non-financial ector. Ar the core of the analy~i~ is a theoretically nm,i~tent mr,dcl developed from -'>Cquenual ordering of thirteen _.,cparate ratio .... The rntio~ pro\'idc focus on three major area, of concern 10 the analy~t: rnk e'lposure. pro-fitability. and growth . A~ with analysi~ applied to non-financial corporations, result are mtended to tlcmon_.,trate difference~ hetwcen competmg tatcmcnh anti to allcm for analysis through time. Our di,cu..,,ion con~ist~ of four parts . In the liN _.,ection. the general nature ofthc am1.l}tical -'>Cheme i~ di.,cu .. _.,ed. St.:cond. ba_.,ic data are prc,cntcd and analyz-ed . Third. Jn example of model application rs dcvclopeu to dcmon_.,1rn1e use of the technique. Finally. a fourth ,el'tion provide~ conclusion~ and sugge!>tion_., for future re. earch . <.;cneral Structure of Anal)Si The ba.'>1c prt!mbe in the developmcm of our model is that management _.,trategie1, are reflected in a _.,cries of deci~mn~ 'NhO!-.e chain effect~ can be mca~urcd through the use of ~pecific ratio~. Whrle nol new in concepl. 1hi view repre cnt~ a new framework for linking key financial variables to policy stimuli. Previous example~ of ~imilar tormula1ion~ can be found in lbarrcche ( 198'.!). To tacihtatc under~tanding of the general scheme. we have developed a graphic pre,entatmn of the model in Figure I. following. Close monitoring of the model and anendant financial Matement, throughout our discussion is highly recommend-ed. As depicted in Figure I. the model i drawn from a et of thirteen ratios l.truc-42 tu red in ~equential order. Each of the ratios act as a proxy for pecific respon e variable to policy Mimuli. A~ a first step in the analysis, the variables were isolated from informa tion provided by bu~ine ~es and agencies acting as either clients or invc~tmcnt ~ourcc,. The ratio l.'cre then developed such that a clear chain of re~ponse could be tr.iced by ~tep-wi e pairing of the ratios. With thi framework m mind we can cla~sify the ratio into two type~: fundamental or ba~ic: ratio~. and chain or trigger ratios . The fir~t group induc.k:5 ratio~ which mea,urc the effel't of a given policy action. The ~cconJ deal with rallm which linl-.. ~c4uentially the chain of reaction from invewnent decision\ through profit margin~ and. ulumate ly. growth potential . If the analy~i~ i~ ba,ed on chain ratio~. a hackward cxplanmion of each ratio can be achieved hv analvL· ing the ratio immeJiatel} preceding. Thi, lancr relation~h1p can be <lem~n,tra~eJ algcbraicall) "ith the equution RI 3 = RI x R::! x R4 x R6 x RS R l O x RI::!. The model 1s accordingly ~een to be comprised of eight chain ratio~ and five ba,ic ratio~. The ,truuurc can be exploited to explain . through a backward analysi~. the detcnnination for each ,tep. The Internal Gro" th Index. for ill51ance, can be .. explained" by the Rewrn on E4uity and the Retention Ratio. L1kew"e, the Return on Equity can be explained by the Pnmury lnve. unem to Equity Ratio and 1hc Return on Primary Ime,tmem. Followmg 1h1h re.i,oning, the an.ily,i, progresse~ 10 the fir~t ratio in the chain. th.: Margin on Primary Income. Each oflhe ratio!> t:an be vieweJ ar, the re!>ult of interacting financial deci!>ion:,. ,ind of external hu,inc~~ condition!,. We would expect that change!> in the economic cnvironmenl. for in,tancc. v.oultl have a direct effect on the bu,111e,!, mix and. accordingly. return, to intermediat ion. This. m turn. would influence the overall pt'rformance of policy a<.:tion, de~ignetl 1<1 max11niLe return~ to equit). A!> il-lurnatetl in the following ~ection. the modd lcmh it-elf easily to policy anal)'~b and overall performance evaluation . 13}1sic Finandal . tal emcn1, and Data Definition~ Our J1M.:u,\ion here i!> hmiled l!l tinanci.11 ,tatemcm, ot commercial banl~ for cahc of prC!,Cnlation, though an e'<ten,1on may be easily made to other tin~ncial mtcrmedianc,. A!> mentioned above. the major area, of concern for the anal:,!,iS arc ri~l-.. return. and growth. Rb~ in thi, contc,t i!> mea,urcd a, the npo~urc of the in~tl1Ut1on to non-tradi11onal area~ of mve\tment. Protilabihtj mea;ure~ arc applied again~! tradnwnal and non-traditional inve~tment and mcomc generator~. while internal growth poten11al i~ mea~urcd 1n t.:rrns of retention of earning~. To illu~trate thc;e area~. Figure'.!. below. presents a ··1ypical .. ~et of commercia l b,rnh. financial Matcmeni- . Stlllcment c.-..1tegories are numbered sequcn· tially for later applicauon 10 the ;tep-wbe analysb. All income ~tatcmem categoric:, are prcccdcd by the letter A. a,;et categoric~ by the letter B. and liability or e4uity categoric~ by the letter C. 43 .... .... f:trnm 1111 Prt111Jr) lnn>111c 1'11tJI 'r 1.:ld hl Pnmat) In ·omc , tdd I lltUl'lll \ Fij!Ure I ~l'lllll'lllial lfotio \Jodcl \•t Ill Pn111.1r) I Ill I lllll' lotal ,\ d Turnml'r IPnmar)) on lmc lllll'nl X Pnmar) Jn,c,tmcnt 111 Total A"l:I' Return on Prunar) Jn,c,tmcnt X = Pnman lml',tllll'III to Equll) Rl·turn on E4Ull) X Rctcnllllll Ratm Internal Grn" th 1111.k X Fi~ure 2 Basic ommercial Bank Financial ta tement (Year ending D •cember 31, 19 _ _ ) AMO NT CATEGORY OPERA Tl G INCOME Intcre,t & fee\ on loan, lntereM on Fed Fumb Sold . etc . lnterc,t & diviJenJ:. on Securitic~ Other Income TOTAL OP R TING I COME Salarie, Pen,,on & other hencfih E,pen,e on Fed Fund, purcha~eJ lntcrc,t on Dcpo,1t~ Other intc:rc,t paiJ Net occupanc} expen,c Supplie, & equipment npen,c Prm i~ion lor loan lo,~c, Other expcn,c~ Aprlicahle income taxe, NET I CO 1E 8.\LA '\CE SHEET In IO00' , of Dollar, S280.000 75.000 20.000 35.000 410.000 50.000 15.000 45.000 180.000 15.000 8.000 12.000 18.000 ::?2.000 5.000 -10.000 Al A2 A3 A4 AS A6 A7 A8 A9 AIO All Al2 Al3 Al-I Al5 Al6 (Statement of Condition: Decemher JI. 19 __ ) ASSETS Ca,h & Juc from hank, U.S. Go\l. & gene) ohl. State & Mumc1pal ohl. Other Secunuc, Loan, (net) Fcd Fuml\ Sold lntcre 1 recei,ahle Prcmi"-'' & equ1pme111 Other a,,c1, TOTAL ASSETS AMO NT CATEGORY ::!30.000 Bl 110.lKlO B::? ::?-10.00) B3 600,000 84 ::?.::?00.000 B5 ::?50.000 B6 -10.000 87 70.000 B 80.000 B9 3.8::?0.000 BIO LIABILITIES & EQUITY Demand deposit~ 500.000 Cl Time depo~it~ 2.500.000 C2 TOT AL DEPOSITS 3.000.000 C3 Fed Fund purcha~ed 350.000 C4 Other ~hart-term borrowing 110.000 cs Other Liabilitie 90,000 C6 Note~ & debenture~ 20,000 C7 Common Stod 50.000 C8 Paid-m surplu~ 50.000 C9 Retained earning~ 150.000 Cl0 TOT AL LIAS . & EQUITY 3.820.000 CII To facilitate development of the model. ,everal ddiniuon~ of ,tatement data arc appropriate. In the fir\t inMance. a maJ1)r area of current concern i~ the tendency of mtcrmediarie~ to deviate from trad111onal mve,rment~ and. according!). ,ourcc~ of profit. A fir,t ,tep m analyzing the ,tatcment\ i~ a cordingly a d1fferentia11on of trad1t10nal ,ourcc of income from other. more recent. trend~. The following defimt1on~ arc imcndcd en tanlitalc the dctcrmmation of managerial directiom relative 10 m,.e,1111ent Mratcg1e~. ( I) Primary Income = (Al + A:!) (2) Secondary Income = (A3 + A4) {)) Co,t of fund, = (A8 + A9 + A 10) (4) Return on Primary income - (Al + A2) - CAR+ A9 + AI0) (5) Return on Total income = CA5) - (A8 + A9 + AI0) (6) Primar1 lnve\lmenl = {85 + 86 + 87) (7J Equity = CC8 + C9 + CIOJ A i~ readil) apparent, the lir<,t fi,·e dcfi111t1om, deal ,, ith income ~tatcment cla~~ificauon and the la,t two wuh the halance ,heel. It i~ 11nportant to dilkrentiate bct,,een primal) and ~econdary ,ource~ of im:ome in order to appreciate the enhaneemem of profit through m1rcxluct1on of ,econdary re, cnuc ,ource,. Since the pa,~age of the Banking Act in 1980, a general trcnJ to\\ ard:. ,econdary, non-traditional, ,ource, of revenue ,·an be lound in many financial in,titution,. Whtie the,c acti\ itic, can provide ;igniticant le, eragc to-prntitabilit). they abo ~ervc to increa,c the ri,k expo~urc of the in;ti tution . The delinuion, outlined are thm mtcnded to \imphf) meawre, of differential rbk and return . imilarly. a categor) .. primary in,e;tment"' b i~olatcd on the balance -.hect. Slightly dtflcrcnt from the more familiar .. ri~k inveMment. " thl\ mca,urc~ the portion of a,,et\ de,otcd to 1raJit1onal revenue generator,. Figure 3 ~how~ each of the ratio~ in formula form am] offer~ a bnef interpretation of each . When a ratio is the product of two preceding ratio~. that relation hip 46 is expressed in algebraic form (e.g. R3 = RI x R2 means that the Total Yield on Primary Income (R3) can be calculated as the product of the Margin on Primary Income CR I) and Bu iness Mix (R2) ). Note also that ratio are presented in category notation con~istent with that u~ed in Figure 2. Figure 3 The Ratio ·: alculation and Int rpretation RATIOS (RI J Margin on Primary Income HOW CAL TED Return on Primary Income Primary Income = (Al +A2) - (A8+A9+AI0) (A I +A2) An 1mlicat1on of the margin available a~ a con~cquence of intermedia-tion activitic~. Return on Total Income Return on Primar) Income (A5) - (A8+A9+AIOJ (Al +A2) - (A8+A9+AIO) A mea,ure of the relative ,1gnificance of pnmar:r (intermediauon) operation, in the overall ~ct ot activ11ie~. (R3J Total Y1ekl to Primar) Income !RIIX(R2l Return on Total Income Primary Income (A5) - (A8+A9+AIO) (Al+A2) Total margin a, it rdate, to rrimary 1m.:omc. (R-4) Yield Etticiency Net Income Return on Total Income Al6 (A5) - (A8+A9+AIO) Demonstrate~ after-tax doll:ir, a, a rcrcentagc of total yield. ,how~ abilit) of management to control O\'crhead cxpen~e, (RS) ct to Primary Income (R3JX(R-4 ) et Income Primary Income (Al6) (Al +A2) Show~ after-tax profit~ per dollar of intermediation income earned. 47 (R6) Total Asset Turnover (Primary) Primary Income Total Assets (A I +A2) (BIO) Measure the ut ilization of the firm·, a!,\Cb A ratio below the induMry average indicate, inefficicnc) m u,c of a, ailable assets. {R7) Return on Investment (RS)X(R6) Net Income Total Assets (A 16) (BIO) Traditional!) meawred retu rn nn invc!>tmcnt (ROI) (R8J Primary lnve tment to Total A~\eh Primary Investment Total A~~cts (85+ 86 +87) <B 10) Indicate, the extent to v. hich a,,ch arc subicct to ,tam.lard inter-mediation component, of risk. (R9l Return on Pnmar1 lnvc,tmcnt (R7)X(R8) = Net Income Primary Investment (Al6) (B5 + B6 +B7) A mea,urc of the rate of return generated through 1ntcrmcdiat1on mve,tmcnt~. (R I OJ Primary (nvcMment to Equit1 Primary Investment Common Stockholders' Equity (85+86+ 87) (C8+C9+CI0) A mca~ure of equity capital \Upport for intermediation 1nve,tment. (R 11) Return on Equity (R9)X(RIOJ ct Jncomc Common Stockholders ' quity = (A 16) (C8+C9+CI0) Traditional mea,ure of return to common stm:kholders · investment. 48 (R 12) Retention Ratio Retained Earnings Net Income (CIO - CIO t=O t=-1 (A16) A mea,ure of the firm·, policy regarding retention of earning retained . (R 13) Internal Growth Factor (RI l}X(Rl2) Retained Earning, Common Stockholders' Equity (CIO - CIO t=O t==-1 (C8+C9+Ci0) A mea,ure of mtcrnaJI} generated growth of common ~tockholdcr~ · equity . Data Ana l}sis Two \et, of bani-. Jata were developed covering the period 1976 to 1982 10 illu,tratc pra1:11cal u:.age of the model. The fir~t data ,ct is dra" n from a South we tern Bank. termed here .. Bank A." The !.econd is dra\.l.n from a Northea~tern Bani-.. termed here .. Bank B." Bank A ~erves an agriculrural and mining area in a generally pro~perou~ climate. Bani-. B ,ervc\ an urban area with mo,1 of ib clicntele in white-collar ~en ice mduwy cmploymen1. Other. le~~ .,1gnif1cant bu~ine, . i~ c1mdul·ted with local bu,ine,~c, and governmental office,. Finanl' ial ,tatemen1, for the two bani-., were: analyzed in conformit} with model ,tructurc Re~ult~ arc prc~cnted in Figures 4 and 5. Although daia arc real. no attempt i~ m.ide to make ~pecific hypothc e~ regarding the bunh . Our goal i, 10 ~imply ,how the u~c of the model m a pragmatic env1ronm<!nt As can be seen rn the table,. the Margin on Pnmur), lncomc ha~ decreased for b01h bank,. Po~,ihlc explanation~ for th1~ behavior arc incrca:,ing competition (The Bankmg Act) and the :,lowdown 111 economic activity 1x:curring in l98l. In following 1he financial mi>. of the l~o bank'>. Bank B appear~ to be main-taining a much more consen·ative posture, though the primary inve~tment 1urno,er is high . The combination of thc~e chara terbtic:, ,ecm, to be henelkial for the bani m that profit murgins arc pveralJ quite ,olid. Bani,. A appear, more aggre:,sive in policie:-. . The primary invcMmem of the firm dropped ,harply following deregulation. and a smuller e4uity ha:,,e to :,upport mvestmenrs wal, tolerated. The lower profit margins throughout suggest a more competitive climate. Be th hanh ~ccm tn have changed their polk:ie, ~ince the banking act. though percentage changes through time retlcc1 the :-.low movement of commercial banh to external change . Both banb shov. ~ubslantial earnings retention. po:-.sihly reflecting either higher ma rgin. on e4uity or reaction to the changing economic en ironment. The step-wise Mructurc or unaly. is is able to n,olatc major differen cs between 49 Figure ..J Ratio : Bani-. A 1976 1980 1982 Margin on Primaf} Income 0.4816 0.3170 0.3131 Bu ine Mix 1.23 I 2 1.2626 1.3331 Tomi Yield on Primary Income 0.5930 0.4002 0.4174 Yield Efficienc1 0.2194 0.1620 0.1938 Net to Primal") Income 0. 130[ 0 .06-18 0.0809 Total Ai.i.et Turnover ( Primary l 0 .0567 0.0950 0.1026 Return on lnvei.tment 0 .006'.! 0.0083 Pnmar) Inve tment to Total A~seti. 1.9755 1.8358 1.6755 Return on Primary Invei.tment 0.01-16 0 .0114 0.0139 Pnmar} InveMment to Equit) 7.-1088 9.5121 10.4796 Return on Equit} 0. 107Q 0.1076 0. 1458 Retention Ratio 4. 1910 5.2228 -+ 4188 Internal Growth Index 0.4522 0.5618 0 .6443 the bankl, a \\Cll a~ capture ch angel, m policiei. through tune. In particular. policy change v.h1ch alter the inve. tment mix of the inl,titutton~ arc rellected through both income i,tatement, and balance 5hectl,. onclu ·ion and Po. siblc E:l. tcn. ion The model developed here offers simplicity of pre~cntation and interpretation . Like the DuPont method of ratio analysi~. it moves backwards from a single ratio of value through other rat1oi. and to consideration of major financial statement variable . The comparison with other firms offers considerable ini.1ght to manage-ment posture. Viewing a tirm'l, behavior through time allowi. the analyst to noie changes m policy and the impact of such change on the fi nancial po ition of the firm. 50 Figure 5 Ratios : Bank B 1976 1980 1982 Margin on Primary Income 0.5044 0.4820 0 .4329 Bu,ine1,~ Mix 1.2259 1.230-l 1.2562 Total Yield on Primar) Income 0.6184 0.5931 0.5•B9 Yield Efficiency 0. 1699 0.1788 0.2073 Net to Primary Income 0. 1051 0.1061 0.1128 Total A!,SCt Turnover (Primary) 0 .0706 0.0951 0.1102 Return on lnve~tment 0.0074 0.0101 0.0124 Primary lnveMmcnt to Total A!,!,Ct~ 1.7678 1.6393 0.7477 Return on Primary Investment 0.0131 0.0165 0.0217 Primary Investment to Equity 8.7868 9. 1451 8.0838 Return on Equ1t) 0 . 115:! 0. 1512 0.1755 Retention Ratio 5.0179 -UOOR 4.1677 Internal Growth lnde, 0.5781 0.6R04 0.7314 A1, is the ca~c with any analyi..i~ of thi, ~ort. of cour,e. re~ult1, arc subject to the interpretation and the b1a, of the analyst. The ratio~ tlcvelopcu here arc not mtenucu to cncompa, all area, of o.:oncern . Compari on~ of varying depo it mix arc helpful in mea~uring co~t efficiency. A hreakout of loan ca1egorie1, can be c11pecially helpful in gauging the ri~J.. of the lending portfolio. Que~uons of capital auequacy arc not directly addressed by th,~ analysi1.. nor arc change~ in capitaliza-tion mi which appear more perva:,ive in recent year . Given the ch,mging climate in which financial instnution~ mu,t operate and the need for simplicity and clarity in their analysis. we feel the equential ratio model offers an important Mcp coward~ greater under~tanding of bank operations. Clearly. further research in comoming financial ~tatcmcnt data to address a broader range of concerns seems promising. Statistical testing of model implications for expected profitabilit or risk abo appear. to he a potentially fruitful area for investigation. SI Rderences Bellemore. Doughis H .. and R11.ch1e. John C. Jr. lmestments: Principles. Prac-tices. Anal) · . 4th Ed . Cincmnau. South-Wot.em Publishing Co .. 197~ . Helfen. Ench A. Technjqu~ of Finan ial \nal~sis. Ho~wood. Ul inois: Rlch .. rd D. lrv.in. Inc .. 198:?. (barrechc. Santiago S . .. ~1cxlelo lie Anafo,1~ Fman.:1ero para lll!>tm1ciones Ban-caria.s." \looografias financitras lB-\1- l'1, (Vol. I. =::!. 198:?J. ______ . .. Anali~1-.. de lnfonnac1,1n Fmanciera para Toma de Deci-siones ... S.A . . ~fc.,1co. Editor h1I If. r3a. Ed .· I 9801 \iood~ ·s Jme~tor., Seri.ice,. Inc . .\ (ood~ ·s Bank ,md Hnaoce \lanual. New York: Variou., Ednion,. Moore. C.L and Jacd1d,e. R.K .\lanagerial Accountin:?,. 5th Ed Cincmnati: South-V.e 1cm Pubhshmg Co . . 1980. We,ton. J. Frc<l anJ Brigh.m1. Eugene F. E,,ential, of \lan~erial Finance. 7th Ed Chicago. The Dr~den Pre ~- 19~5 Santiago lbarrechc i!> an A,M1Ciate Prole..:,or of Information S:y 1em. in the Deparl· mem of Management. College of Bu,me,~ AJm1m-.tra11on at The Um\'er~ny of Texa, al El Pa,o Rohen D Tollcn 1~ an A,,ociate Prr>fc,~c,r of Economic~ and Fmam:c in the Depanmcnt of Economic, anJ Finance. College of Bu,1ne,, Adminhtra11on a1 The Univcr it) of T.:xa~ ar El Pa,n. 52 

Stepwise Analysis of Bank Statements

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Stepwise Analysis of Bank Statements

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