The Financial Analysis of The Royal Bank of Scotland Group - Research Paper Example

The Financial Analysis of The Royal Bank of Scotland Group Introduction This financial analysis report examines a high profile bank headquartered in Edinburgh, the Royal Bank of Scotland to evaluate the bank’s performance and financial health. An overview of the UK banking industry is considered along with this financial analysis. The financial analysis covers the bank’s common size income statement and balance sheet. In addition, financial performance evaluation ratios on the bank’s liquidity, solvency, and return on investment and capital structure have been used to draw conclusions about the bank’s financial health and performance. The Banking Industry in United Kingdom The Royal Bank of Scotland (RBS Group) carries out its business activities in the United Kingdom, Asia, Europe, the Americas and the Middle East, with more than thirty mullion customers. Large corporations, institutions and individuals are among the customers, that the group provides its products to (RBS Group, 2013). Despite the adverse effects of the financial and economic crises that faced the world and the United Kingdom, banks and the economy of the United Kingdom began this year with a stronger position, compared to last year (Accenture, 2012). The last five years have been characterised with poor performance among many companies. In the United Kingdom, the banking industry is unique. This is because it is large and diversified, accommodating a large international industry (Accenture, 2012). As a result, competition is great, and individual banks have to analyse their strategies to ensure superior performance in the financial markets, given the volatile, current and future economic conditions. Income Statement Analysis From the common size income statement of the Royal Bank of Scotland, it is evident that revenue has been decreasing each subsequent year, for the last three years. For instance, the bank’s revenue for 2012 was £17, 941 Million, compared to revenue of £24,651Million earned in 2011 and £31, 798 Million earned in 2010 (RBS Group, 2013, p, 45). This trend shows that revenue has been decreasing significantly. Subsequently, the Bank’s operating loss increased significantly, over the three years. In 2010, the Royal Bank of Scotland had an operating loss of £469 Million. In 2011 the operating loss increased to £1,190 Million, while it further increased to £5,165 Million in 2012. The same trend was recorded in loss after tax of the Royal Bank of Scotland for the three years of analysis. For instance the Royal Bank of Scotland recorded a loss after tax of £1,033 Million in 2010, while the figure increased to £2,317 Million and £5,806 Million for 2011 and 2012 respectively (RBS Group, 2013). This resulted to a loss for the period of £1,666 Million in 2010, which increased to £1,969 Million in 2011 and £5,806 Million in 2012 (RBS Group, 2013, p, 45).. The Royal Bank of Scotland has never made any dividend payment for the last three years, probably because it has been making losses from its business. Given that the Royal Bank of Scotland has been making losses for the last three years, the earnings per share portray a negative value. For example in 2010, the earnings per share for the Royal Bank of Scotland were -5.00p, while in 2011 and 2012 recorded earnings per share of -2.13p and -53.70p, respectively (Hargreaves Lansdown, 2013). This shows a trend where the performance of the Royal Bank of Scotland has been deteriorating. Balance Sheet Analysis From the common size balance sheet of the Royal Bank of Scotland, the current assets to total assets ratio for the three years under analysis is averaged at 62.62%. In 2010, the bank’s current assets to total assets ratio was 65.66% while in 2011 and 2012, the Royal Bank of Scotland had a current assets to total assets ratio of 60.13% and 62.06% respectively. The common size balance sheet of the Royal Bank of Scotland shows no short term liabilities for the three years under analysis. Therefore, there are no short term liabilities to total liabilities and shareholders’ equity ratio for the three years. However, the bank’s current ratio, which is the total current assets divided by the total current liabilities, should be high. Since the Royal Bank of Scotland had no short term liabilities, the gap between current assets and current liabilities is 62.62%, for the three years under analysis. The bank’s net worth for 2012 was £70,448 Million, while in 2011 and 2010, the bank had a net worth of £76,053 Million and £76,851 Million respectively (Hargreaves Lansdown, 2013). The average net worth of the Royal Bank of Scotland for the three years was £74,451Million. This is a favourable indicator for the financial health of the Royal Bank of Scotland because it is not leveraged; hence investors will not fear of any hindrance to the expansion of their investments. Consequently, the bank will not have problems associated with decreasing the percentage amount that it will have to reinvest back because settling short term liabilities using assets. Current assets decreased significantly during the three years, from 2010 to 2012. Provisions, represented as non-current liabilities in the common size balance sheet of the Royal Bank of Scotland, decreased significantly, over the three years. In 2010, the bank had provisions of £2,142 Million while in 2011 and 2012 the provisions recorded were £1,945 Million and £1,141 Million respectively (Hargreaves Lansdown, 2013). Since there are no long term borrowings, it means that the bank does not depend on long term debt in financing its operations such as acquisitions. The bank’s balance sheet indicates that share premium account was flat, over the three years, while minority interests increased, implying that the Royal Bank of Scotland was involved in acquisitions during the three years under analysis (Hargreaves Lansdown, 2013). The balance sheet of the Royal Bank of Scotland reflects that property, plant and equipment decreased over the three years, 2010 to 2012. In 2011, the bank’s property, plant and equipment decreased to £11, 868 Million from £16,543 million, recorded in 2010 (Hargreaves Lansdown, 2013). The value of property, plant and equipment decreased further to £9,784 Million in 2012. Other non-current assets such as investments also showed a decreasing trend over the three years. This trend is alarming, especially when the bank may be required to borrow funds. Given the huge difference between the book value of the shares of the Royal Bank of Scotland in, the bank’s stock may not be performing better in the stock exchange in future. The high market-to-book value of the bank’s shares shows that the bank’s financial may not as strong to guarantee superior performance. Ratio Analysis Ratio Formula 2012 2011 2010 Net Profit Margin Profit after Taxes/ Sales or Revenue -5,634/17,941 = -31.40% -2, 317/24,651 = -9.40% -1,033/31,798 = -3.25% Return on Assets Profit after Taxes/ Total Assets -5,634/1,312,295 = -0.0040 -2, 317/1,453,516 = -0.0020 -1,033/1,696,486 = -0.0006 Return on Equity Profit after Taxes/ Shareholders’ Equity (Book Value) -5,634/68,130 = -0.0827 -2, 317/74,819 = -0.0016 -1,033/75,132 = -0.0137 Total Assets Turnover Revenue/Average Total Assets 17,941/1,312,295 = 0.0137 24,651/1,453,516 = 0.0170 31,798/1,696,486 = 0.0187 Price to Earnings Ratio Current Market Price Per Share/After Tax Earnings Per Share 3.30/6.30 = 0.5238 3.30/-0.08 = -41.25 3.30/5.00 = 0.66 The negative values of the net profit margin that have been increasing over the three years imply that the Royal Bank of Scotland made losses. In 2010, the bank’s net profit margin was -3.25%, and this indicates the percentage of the loss that the bank realised from its operations. The net profit margin ratio increased to -9.40% in 2011, and -31.40% in 2012. The net profit ratio measures the net income dollars generated by each unit of currency of sales, and should be high to reflect healthy financial performance (Gibson, 2012, p, 327). The return on assets value, which deteriorated over the three years of analysis, implies that management of the Royal Bank of Scotland is only capable of making low achievements in performance on all the firm’s assets. The same trend was recorded on the bank’s return on equity. This means that thee Royal Bank of Scotland was not earning a good return on its assets for the three year period that has been analysed. In addition, the return on equity for the Royal Bank of Scotland might have been low because the bank’s capital structure. Firms that fund their assets primarily with equity normally show a lower return on equity than firms that fund their assets primarily with liabilities (Ledgerwood, 1999, p, 223). As noted earlier, from the balance sheet of the Royal Bank of Scotland, there were no current liabilities in the three year period that has been considered for analysis. Therefore, this implies that the bank must have funded its assets through equity, and not through liabilities. This is what caused a low return on equity ratio that was recorded by the royal Bank of Scotland in 2010, 2011, and 2012. The low and decreasing total asset turnover ratio implies that the bank’s performance worsened each subsequent year. In 2010 the total asset turnover for the Royal Bank of Scotland was 0.0187. The ratio decreased to 0.0170 in 2011 and 0.0137 in 2012. Given that the total asset turnover ratio measures efficiency in the use of assets to produce sales, a firm with a higher total asset turnover, uses its assets more productively than a firm with a lower total asset turnover (Needles, Powers, & Crosson, 2008, p, 209). Therefore, productivity in the use of the bank’s assets decreased each year from 2010 to 2012. It is vital to note that this financial analysis on the performance of the Royal Bank of Scotland has made some limitations. First, the ratio analysis has indicated the areas where the bank’s performance is either strong or weak. However, the analysis has not explained the causes of such strengths or weakness in performance of the bank comprehensively. Secondly, the analysis is only comparative in terms of period. This means that the analysis compared performance of the Royal Bank of Scotland for the three years. The analysis did not compare the performance of the Royal Bank of Scotland with another firm in the United Kingdom banking Industry to evaluate performance. The financial ratios that have been calculated to contribute to the formulation of inferences of this analysis are based on past data. Taking into consideration that the economic environment is characterised with price level changes, then the rise in inflation may have eroded the relevancy of this past data. Similarly, historical data which has been used in the analysis has not taken into consideration the value of money in the present day economic situation, leading to reduced validity of the analysis. The main source of data of this analysis is the Royal Bank of Scotland annual report. Therefore, the analysis has been based on annual reports only. Annual reports provide financial estimates, and accounting approaches differ from company to company or industry to industry. In addition, there are many assumptions that are made in the preparation of financial reports. This means that the analysis is not based on full company information. For instance, the current performance of the Royal Bank of Scotland could be better than what was portrayed in the 2012 financial statements, but such information will be available in 2014, when it would have become past data. Also, reliance on annual reports only for financial analysis means that some important information about performance is left out. For instance, management of the bank may be aware why the bank is recording losses, but this information is not available in the financial statements. For instance, downsizing may result to disclosure of financial information that shows a decreasing trend in performance. Without supporting information about a firm’s performance, it is difficult to establish the root cause of poor performance, as portrayed by financial statements. Main Risks Facing the Royal Bank of Scotland Group in the Last Three Years The Royal Bank of Scotland Group has faced several challenges associated with the economic environment. Since the beginning of 2007, most companies were adversely affected by the financial and economic crisis. This led to poor financial performance among many companies, and some had to collapse. The Royal Bank of Scotland Group also experienced adverse effects that resulted from this economic crisis. These challenges posed major challenges to the performance of the Royal Bank of Scotland Group. Some of the main challenges and risks that the Royal Bank of Scotland Group faced in the last three years that have been analysed are explained as under. The Royal Bank of Scotland Group faced challenges associated with the European economy. The Euro zone crisis saw the economies of many European countries go under due to the huge debt. Therefore, the economies of most of the European countries that were debt laden risked collapsing. The adverse effects of this crisis were contagious and it spread across most of the European countries. Given that the Royal Bank of Scotland Group operates in most of the European countries and the Americas, the bank was severely affected. This crisis posed adverse risks on the financial performance of the Royal Bank of Scotland Group. Even with the looming danger of slipping of economies from falling inflation to deflation, the European Central Bank showed little signs of solving this crisis. The Royal Bank of Scotland Group faced serious problems that posed major risks because it had to use huge sums of money worth of assets to meet international capital standards. This is because the Royal Bank of Scotland Group is an international banking group because there was little or no progress towards structural reforms by the euro zone (Kling, 2013). Secondly, the Royal Bank of Scotland Group faced challenges associated with the collapse of the branch divestment deal. The bank had set a deal to sell more than three hundred of its bank branches. The initial divestment deal to sell the aforementioned bank branches collapsed in 2012. The European Commission had forced the divestment deal the Royal Bank of Scotland Group (BBC, 2013 and Jenkins, Thompson, & Oakley, 2013). This collapse posed risks of poor financial performance for the baking group. The Royal Bank of Scotland Group also faced risks associated with the LIBOR rate fixing scandal that caused a wide spread outrage (Royal Bank of Scotland, 2013). Some of the bank’s employees decided to influence some LIBOR settings at the bank against the set code of conduct, for their own benefit. These individuals were able to perform the unethical acts because there were control and risk management failures in the systems of the Royal Bank of Scotland Group. These events resulted from the financial boom years such as the attempted LIBOR manipulation. This manipulation was aimed at favour trading, with the aid of traders and brokers. When the scandal was revealed, the Royal ban of Scotland Group was at a risk of closure because this scandal was among the greatest breaches of ethical conduct by banks. During the three year period that have been analysed, the Royal Bank of Scotland faced another major risk due to systems failure in June 2012. The technical failure of the bank’s IT Systems, led to loss of crucial data for the bank’s operations (Royal Bank of Scotland, 2013). The technical fault that occurred in the systems of the Royal Bank of Scotland Group Systems caused major inconveniences to the company’s clients for a period of one month (Treanor, 2012). The bank risked legal redress from the affected clients, and had to spend more than £100 Million to compensate the affected clients. The overall trust levels among customers of the Royal Bank of Scotland Group were impacted by some issues such as the Payment Protection Insurance, interest rate-swap products and packaged accounts. The activities that took place within the bank’s business lead to unequal treatment of clients of the Royal Bank of Scotland Group. This unfair treatment led posed a major risk on the bank’s performance, given that it faces stiff competition from other Large European banks. However, management of the Royal Bank of Scotland Group has corrected the situation, and customers are provided with the right products to meet their needs currently. Improvements have been made to create incentives for staff members of the bank to increase service and reduce sales (Royal Bank of Scotland, 2013). Finally, the Royal Bank of Scotland Group was faced by a risk arising from allegations that the bank seeks to kill small firms and issue is under investigation. The bank is alleged to force small firms to its Global Restructuring Group. This happens when such companies break minor rules of loans. Such minor breaches of rules include late filing of minor financial information. The bank then forces the small firms to pay high rates and fees. This might lead to the collapse of the firms and possibly, allows the bank to buy their property and assets cheaply (Wilson, 2013). This issue poses a risk on the bank’s performance. References Accenture., 2012, May 4. State of the United Kingdom Banking Industry 2012. Retrieved from http://www.accenture.com/SiteCollectionDocuments/PDF/Accenture-State-of-the-Banking-Industry-2012.pdf BBC., 2013, September 27. RBS sells 314 Bank Branches to Corsair Consortium . Retrieved from http://www.bbc.co.uk/news/business-24304526 Gibson, C. H., 2012. Financial Reporting and Analysis. Mason: South-Western Publishers. Hargreaves Lansdown., 2013. Royal Bank of Scotland Group plc Financial Statements & Reports . Retrieved from http://www.hl.co.uk/shares/shares-search-results/r/royal-bank-of-scotland-group-plc-ord-gbp1/financial-statements-and-reports Jenkins, P., Thompson, J., & Oakley, D., 2013, May 1. Rivals charm Royal Bank of Scotland over Rainbow Sale. Retrieved from http://www.ft.com/intl/cms/s/0/d9021542-b27c-11e2-a388-00144feabdc0.html Kling, M., 2013, August 16. UK Telegraph: Eurozone Crisis Isn't Over. Retrieved from http://www.moneynews.com/Economy/eurozone-recession-crisis-euro/2013/08/16/id/520738 Ledgerwood, J., 1999. Microfinance Handbook: An Institutional and Financial Perspective. Washington, D.C: World Bank Press. Needles, B. E., Powers, M., & Crosson, S. V., 2008. Principles of Accounting. Boston: Houghton Mifflin Press. RBSGroup. 2013. 2012 Financial Results. Retrieved from www.rbs.com/annualreport Royal Bank of Scotland., 2013. Our CEO discusses Key Issues. Retrieved from http://www.rbs.com/sustainability/rbs-and-sustainability/question-and-answer.html Royal Bank of Scotland., 2013. Stakeholder Issues. Retrieved from http://www.rbs.com/sustainability/rbs-and-sustainability/stakeholder-issues.html Treanor, J., 2012, August 2. RBS Computer Failure to cost Bank £100m. Retrieved from Jill Treanor Wilson, H., 2013. Royal Bank of Scotland faces Claims of 'Killing Off' Small Firms. Retrieved from http://www.telegraph.co.uk/finance/newsbysector/banksandfinance/10471671/Royal-Bank-of-Scotland-faces-claims-of-killing-off-small-firms.html Read More