Managing Finance - Kuwait Finance House and the National Bank of Kuwait - Research Paper Example

Managing Finance Executive Summary Ratio analysis is used as one of the financial analysis methods to gauge the financial performance of a firm. The performance is however measured using a benchmark used to compare the ratios. The ratios can be used to compare firms within a similar industry as well as a firm against the industry. In this report, the comparison is between two financial institutions in the Kuwait Banking industry. Kuwait Finance House and the National Bank of Kuwait were compared using their ratios to find out their financial health. The analysis involved getting the financial data from the annual reports of these banks for the years of 2011, 2012 and 2013. The analysis was then done using bar graphs to compare the results that were calculated using the secondary data obtained. After the analysis and interpretations, conclusions were drawn. The paper then ended by looking at the reflection of what was taught in class and comparing it with the analysis that is done here. The relevance is drawn and conclusion was made about the use of ratio analysis in financial management. Table of Contents Executive Summary 2 1.0 Managing Finance 5 1.1 Introduction 5 2. Research Methodology 6 3.0 Ratio Calculation and Analysis 6 3.1 Profitability Ratios 6 3.1.1 Return on Capital Employed (ROCE) 7 3.1.2 Return on Equity (ROE) 9 3.2 Liquidity Ratios 11 3.2.1 Current Ratio (CR) 12 3.2.2. Quick Ratio (QR) 14 3.3 Efficiency Ratios 16 3.3.1 Asset Turnover 16 3.4 Investment Ratio 19 3.4.1 Earnings per Share 19 3.5 Cash Flow Ratios 21 3.5.1 Quality of Profit 21 3.6 Gearing Ratios 23 3.6.1 Net Gearing Ratio 23 3.7 Z SCORE 25 4.0 Conclusion 26 5.0 Reflection 27 6.0 Bibliography 28 List of figures Figure 1 9 Figure 2 11 Figure 3 14 Figure 4 16 Figure 5 18 Figure 6 21 Figure 7 23 Figure 8 25 Figure 9 26 1.0 Managing Finance Comparing Financial Performance of Kuwait Finance House and National Bank of Kuwait 1.1 Introduction Kuwait Finance House is known as the pioneer in the Islamic Finance or Shari’a Compliant Banking. The bank was established in 1977 in the State of Kuwait as the first Islamic bank and it is rating today as the foremost Islamic financial institution in the world. The KFH’s Group banking network has captured a total of seven regions worldwide and has 355 branches. It has more than 475 ATMs and employs more than 800 workers. The National Bank of Kuwait on the other hand was the first National Bank in Kuwait and in the whole of the Arabian Gulf region. The board members and founders of this bank are renowned businessmen of Kuwait origin. The Bank was only established with 13,100 shares that are each were valued at KD 75. The bank has over the years proved to be the leading financial institution in the Gulf region as well as the Arab world. The bank has had a consistent profitability over the years, something that has made it to have a strong financial position as well as an extensive international presence to see it earn some of the most distinguished and worldwide recognized awards. It is much easier to compare the two companies as they fall under the same industry and are based in the same country. They are therefore faced with a similar trading environment that contains similar challenges as well as opportunities. The comparison is also interesting since the two companies are each other’s competitor in the industry and they also compete for same resources and opportunities in within the banking industry of Kuwait. This paper is therefore aimed at analyzing and comparing the financial ratios of the two financial institutions for the three financial years of 2011- 2012 and 2013. The comparison will be done across the years as well as between the companies. The paper will then follow by looking at the interpretations of the analyzed results to find their implications and what the results mean to the banks. Finally, there will be a reflection that will try to provide a feedback on the report and analysis and provide any good thing or bad ones and what can be done about them. 2. Research Methodology The data that will be used to calculate and analyze the ratios of these two banks will be obtained from secondary sources. The published annual financial reports of these banks will be used to provide the financial information that will be used in the calculation of the financial ratios. The financial reports will cover three years including 2011, 2012 and 2013. Three years data is chosen to provide a trend that can be used to draw concrete inferences. Data analysis will be done by calculating the ratios using the MS Excel software and the results will be provided on the report under the discussion of each ratio. The income statement, the balance sheet and the cash flow statements of these banks are used specifically to provide the figures used in the calculations. However, only a few selected financial ratios will be selected for calculation and discussion. 3.0 Ratio Calculation and Analysis 3.1 Profitability Ratios These are ratios that measure the ability of the firm to operate efficiently and they are of great importance to the investors, shareholders, creditors and management (Dennant, 2006). 3.1.1 Return on Capital Employed (ROCE) Return on Capital Employed is a ratio that is used to show the difference between the amounts that have been put on investment in a firm and the amount that is expected by the investors from the investment (Bragg, 2013). The ratio is calculated by the following formula: ROCE = operating Profit / total assets – current assets The following are the calculated ROCEs for the two banks: Kuwait Finance House (KFH) and National Bank of Kuwait (NBK) for 2011, 2012 and 2013 financial years. 2011 ($) KFH: 687, 582,000 / 48,321,067,000 – 39,349,245,000 = 0.0766 NBK: 1,141,202,000 / 48,451,015,000 – 4,520,007,000 = 0.0259 2012 ($) KFH: 1,058,157,000 / 52,278,403,000 – 30,765,857,000 = 0.0492 NBK: 1,163,481,000 / 58,398,176,000 – 5727,164,000 = 0.0221 2013 ($) KFH: 325,191,000 / 16,139,790,000 – 10,002,528,000 = 0.0530 NBK: 958,724,000 / 65,946,268,000 – 8,551,884,000 = 0.0167 Discussion, Analysis and Interpretation Figure 1 below shows the difference in the values of ROCE in the two banks from 2011 and how they kept on changing until in 2013. Generally, the values of ROCE have been reducing since 2011 in both banks. This shows that the profits have not been well invested back into the companies to benefit the shareholders (Siddiqui, 2006). This is usually a sign that the growth of the company has been retarded for over the three years. However, we can see that the ROCE for KFH increased in 2013 that shows that the company has started to invest back the profits to the company in a good way. The two banks could have had large debts that really take time to repay and that could explain the reason for their declining values of ROCE (Accounting Tools, 2014). However, with the recent slight rise in the ROCE value for KFH in 2013, there is hope that the bank would do even better in the future. NBK on the other hand will have to wait until when the weight of the debt begins to subside for it to begin accumulating good values for ROCE. The Kuwait banking industry was said to project a growth of 6% by 2014. KFH was therefore in the right direction to achieving this growth especially by expanding growth in tis international branches. Figure 1 3.1.2 Return on Equity (ROE) Return on Equity is a ratio that is used to show the investors the extent to which a firm utilizes the shareholders’ capital to generate profits (Wilkinson, 2013). It is therefore used as the measure of profits that the shareholders will get in relation to the book value of the equity employed in the firm. To calculate ROE we use the formula: ROE = After Tax Profit / Equity The following are the calculations of ROE for the two banks for the period between 2011 and 2013 financial years. 2011 ($) KFH: 131,930,000 / 5,536,043,000 = 0.0238 NBK: 1,079,652,000 / 8,307,815,000 = 0.130 2012 ($) KFH: 438,477,000 / 5,829,034,000 = 0.0752 NBK: 1,097,234 / 9,059,595 = 0.121 2013 ($) KFH: 149,066,000 / 2,065,221,000 = 0.0722 NBK: 891,764,000 / 9,614,586,000 = 0.0928 Discussion, Data Analysis and Interpretation In general terms, for a company to be able to earn its shareholders some dividends and still have some funds to invest back in the company for its future growth, it is desired that its ROE should be between 10% and 30% (CcdConsultants, 2009). Looking at the presentation of the ROE figures in the figure 2 below, it is evident that the value of ROE for the two banks are running in completely opposite directions. In as much as the ROEs for KFH are not in the bracket of 10% and 30%, they have been increasing since 2011. There was a slight drop in the 2013 ROE that could be explained by the fact that the bank reduced is leverage rate. The ROE values for the NBK have been on the decrease since 2011 also due to the fact that the company is less leveraged. NBK has been in the required bracket of ROE between 2011 and 2012 financial years. In 2013, its ROE value went slightly outside the favorable value due to the continued reduction of leverage that the company continues to experience. The Kuwait banking industry was said to project a 12% growth by 2014. The two banks are not during so badly towards meeting this growth as there is continuous growth witnessed by the KFH while NBK has also been around that figure for the two last years. Figure 2 3.2 Liquidity Ratios Liquidity ratios are those ratios that are responsible for the solvency of the firm’s financial position (WA, 2013). In other terms, a firm is considered to be a liquid firm if it is able to meet its short-term obligations when they fall due. 3.2.1 Current Ratio (CR) This is a liquidity measure that seeks to compare the estimate of the amount of funds to be received in the sort-term and an estimate of the amount of funds to be paid (Irfanulla, 20113). In other words, this ratio seeks to match the current assets with the current liabilities of a firm. The following formula is used to calculate current ratio. CR = Current Asset / Current Liability The following are the calculations of the current ratios of the two banks for the years 2011, 2012 and 2013. 2011 ($) KFH: 28,310,852,000 / 38,043,157,000 = 0.744 NBK: 4,520,007,000 / 39,500,555,000 = 0.114 2012 ($) KFH: 30,765,856,000 / 41,413,425,000 = 0.743 NBK: 5,727,164,000 / 48,578,620,000 = 0.118 2013 ($) KFH: 10,002,528,000 / 12,572,512,000 = 0.796 NBK: 8,551,884,000 / 54,681,486,000 = 0.156 Discussion, Data Analysis and Interpretation A current ratio of 2 to 1 is considered to be the most favorable. The current ratio values of the NBK are very low but have been increasing since 2011 (). The ratio of 0.156:1 as shown in figure 3 shows that NBK has only $0.156 in assets available to cover every $1 that it owes. The values of the current ratio for the KFH have also been on the increase since 2011 and they seem to be higher than the ratio of its counterpart, NBK. For KFH in 2013, the ratio of 0.796:1 shows that the bank has only $0.796 to cover every $1 that it owes. These ratios are not favorable since they show that the banks are not in positions to meet their short-term obligations when they come due (). This could mean that the banks have engaged in too much short-term debts than they are able to repay. The two banks are therefore far from attaining the optimal ratio position. They therefore need to work extra hard in increasing their current assets and reducing their short-term liabilities by paying off their debts. They can also engage more in the long-term debts to enable them reduce the short-term debts so that they can improve the current ratio. Figure 3 3.2.2. Quick Ratio (QR) This is also referred to as acid test ratio and it is a ratio that only concentrates on the most liquid assets of a company which it compares to the company’s current liabilities (MyaccoutingCourse, 2014). It looks at the more readily realizable cash if the firm could settle all the debtor and creditor accounts. To calculate Quick Ratio, we use the following formula: QR = Cash and Marketable Securities / Current Liabilities The following are the calculations of the Quick Ratio for the two banks for the years 2011, 2012 and 2013. 2011 ($) KFH: 2,202,859,000/38,043,157,000 = 0.0580 NBK: 9,864,132,000 / 39,500,555,000 = 0.250 2012 ($) KFH: 2,895,132,000/41,413,425,000 = 0.070 NBK: 11,344,408,000/48,578,620,000 = 0.234 2013 ($) KFH: 1,070,486,000/12,572,512,000 = 0.0851 NBK: 16,884,360,000/ 54,681,486,000 = 0.309 Discussion, Data Analysis and Interpretation The most idea ratio for Quick Ratio is a ratio of 1:1. This would mean that higher ratios would suggest that the firm is healthier. On the other hand, lower ratios will suggest that the firm will be put under pressure to perform. Looking at the data on figure 4 below, the ratio values for KFH (0.05, 0.07 and 0.085) are very low but they have been increasing since 2011. It shows that KFH has to work under a lot of pressure to be able to repay its debts. The industry’s baseline is 0.25, therefore the bank is still way back much behind from achieving the baseline. This shows that the bank might experience more problems in repaying its debts in the future. On the other hand, the ratio values for the NBK (0.25, 0.23 and 0.309) show that the bank has also not met the ideal current ratio requirement. However, being that its ratio values slightly passes the industry baseline in 2013, it shows that, in as much as the bank will have to work under pressure to repay its debts, and it is in a fairly stable position. Figure 4 3.3 Efficiency Ratios These are such ratios that show how effective the management is in using the firm’s assets in generating sales (Morning Star, 2010). 3.3.1 Asset Turnover Asset turnover defines the number of times that the inventory of a firm was converted into sales during a given period. This makes Asset Turnover to be considered as a good indication for purchasing and production efficiency (Rosemary, 2013). Asset turnover is calculated by the formula that follows: AT = Sales / Total Assets The following calculations are for the Asset Turnover for the two banks for the years 2011, 2012 and 2013. 2011 ($) KFH: 97,079,000 / 13,459,833 = 7.21 NBK: 13,898,000 /13,626,848 = 1.02 2012 ($) KFH: 88,708,000 / 14,703,301 = 6.03 NBK: 11,226,000 / 16,424,487 = 0.683 2013 ($) KFH: 246,418,000 / 161,397,900 = 1.53 NBK: 1,734,898,000 / 659,462,680 = 2.63 Discussions, Data Analysis and Interpretation The ideal Asset Turnover ratio is usually considered to be around 4. Higher values are more preferable while lower values are not appropriate. Looking at figure 5, there is a lot of inconsistency as far as the Asset Turnover ratio is concerned. Starting with KFH, the values of the AT ratio have been on the decrease since 2011. The values was high in the first two years (7.21 and 6.03) but decreased to 1.53 in 2013. This ratio is very low, showing that it is a high time that the bank begun utilizing its assets in a more efficient manner or resort to sell them. For NBK, the values have been very low for the first 2 years. However, the value for 2013 shows that the bank is improving on the efficient utilization of its assets. This should continue until the ideal value is met and even surpassed. The industry value is set for 3, therefore the two companies, especially NBK is working hard towards achieving this industry baseline. Figure 5 3.4 Investment Ratio 3.4.1 Earnings per Share This ratio shows the amount of profit that the firm has earned out of each ordinary share (AccountingCoach, 2014). The figures of the earnings per share should be provided in the annual report, but if not provided like in the case of KFH and NBK banks, the following formula is used for their calculations. EPS = Net Earnings / Number of Shares The following are, therefore, the values of the earnings per share for the two banks as calculated for the years 2011, 2012 and 2013. 2011 KFH: 131,930,000/ 19,355,060 = 68.2 NBK: 1,079,652,000 / 7,254,400 = 148.82 2012 KFH: 438,477,000 /2,024,793 = 216.6 NBK: 1,097,234,000 / 6,384,700 = 171.9 2013 KFH: 149,066,000 / 582,497 = 256 NBK: 891,764,000 / 4,128,878 = 216 Discussion, Data Analysis and Interpretation For general purposes, any higher values of Earning per Share are more preferable. Looking at the figure 5 below, the bar graphs show a steady increase in the earnings per share of both the banks over the years three years. KFH starting when the Earnings per share was very low at $68.2, but increased the values increased steadily until it reached $256 by 2013. At the same time, the earnings per share for NBK has also been on the rise from $148.8 in 2011 up to $216 in 2013. These show improving performance of the companies as well as their good financial health status. Figure 6 3.5 Cash Flow Ratios 3.5.1 Quality of Profit This is a ratio that shows the degree of the likelihood of the profit of a firm to continue into the future (John, 2009). The Quality of Profits is calculated by the formula stated below. QOP = Net Operating Cash Flow/Operating Profit The following are therefore the calculated values of Quality of Profit for the two banks for the years 2011, 2012 and 2013. 2011 KFH: 940,655,000 / 1,283,827,000 = 0.733 NBK: 1,773,714,000 / 1,298,852,000 = 1.366 2012 KFH: 971,127,000 / 1,146,221,000 = 0.847 NBK: 1,655,716,000 / 1,289,529,000 = 1.284 2013 KFH: 664,611,000 / 279,736,000 = 2.376 NBK: 6,315,682,000 / 1,439,259,000 = 4.388 Discussion, Analysis and Interpretation To determine whether a profit is of high quality, it would be necessary to consider such a profit one that can be repeated or sustained in the firm. Looking at the values of Quality of Profit for the two banks in the figure 7 below, it is shown clearly that the values are low but have been increasing year after the other. The values for KFH are relatively lower than those of NBK. Seemingly the values of KFH could have been low due to the fact that the bank had not recently invested much on the new technology that can very well improve the value. NBK on the other hand could be having the higher values because the bank has been investing in the new technology that has been helping in increasing productivity as it reduce the costs at the same time. Figure 7 3.6 Gearing Ratios 3.6.1 Net Gearing Ratio This ratio compares how much the shareholders capital is used to finance the debt of the company (MoneyWeek, 2009). The formula below is used to calculate the ratio. NGR = Net Debt / Equity The following are the calculated values of the Net Gearing Ratio for the two banks for the years 2011, 2012 and 2013. 2011 KFH: 40,461,881,000 / 5,536,043,000 = 7.31 NBK: 40,143,200,000 / 8,307,815,000 = 4.83 2012 KFH: 44,025,705,000 / 5,829,034,000 = 7.55 NBK: 49,338,581,000 / 9,059,595,000 = 5.45 2013 KFH: 13,334,839,000 / 2,065,221,000 = 6.46 NBK: 56,331,682,000 / 9,614,586,000 = 5.86 Discussion, Data Analysis, and Interpretation In general terms, the higher the ratio, the more the firm’s debts can be paid by the shareholder’s equity. Therefore, it would mean that the firm is more owned by the shareholders than it is owned by the debtors. Looking at the data in the figure 8 below, it is clear that the Net Gearing Ratio for KFH is reducing but it is still high. This means the bank is more owned by the shareholders’ equity than it is owned by the debtors. The NGR for NBK are also high generally and are increasing steadily over the years. This shows how the firm has been trying every year to improve its equity position to be able to capture more of its debts. These forms could be in these good positions because they ensure they have less and less long-term debts and clear them in time. Figure 8 3.7 Z SCORE This is an indicator of a company’s financial solvency. The values of Z-scores above 2.99 are indicators that show the safety of the firm while those values below 1.81 show the riskiness of the firm to bankruptcy. The values of Z-scores for the 2 banks are very high as shown in the figure 9 below. They therefore show how safe from bankruptcy these two financial institutions are. = ([Working Capital / Total Assets] x 1.2) + ([Retained Earnings / Total Assets] x 1.4) + ([Operating Earnings / Total Assets] x 3.3) + ([Market Capitalization /Total Liabilities] x 0.6) + ([Sales / Total Assets] x 1.0) KFH: 8.6 NBK: 7.8 Figure 9 4.0 Conclusion It is without any doubt that firms that fail most of the time experience poor financial health. Ratio analysis is a good way that firms can employ to become aware of their firms’ financial positions. It is through this way that firms can be able to rectify any possibility that can result to the failure of their firms. Just like in the analysis above, the financial statements are very important in providing the necessary data in calculating the financial ratios. The ratios are then supposed to be compared with the ratios in the related firms in the industry of with the industry figures. 5.0 Reflection Just we’ve learnt during the module, financial ratios are important in helping the management with its basic functions including planning, controlling, coordinating, communicating as well as forecasting. It is also very useful in analyzing and interpreting financial data that would provide us with the information about the financial health of the firm. With the help of the financial ratio analysis, it is easy to compare the financial performance of two or more business entities, especially those that belong to the same industry. The ratio also helps a firm to be in a position to compare its performance to the baseline indicator performance of the industry within which it belongs. This therefore makes us make a conclusion that ratios can only be used in analysis of a company’s performance when there is a benchmark against which the ratios are compared. 6.0 Bibliography Accounting Tools, 2014. Return on Capital Employed. [Online] Available at: http://www.accountingtools.com/return-on-capital-employed [Accessed 15 January 2015]. AccountingCoach, 2014. Earnings per Share. [Online] Available at: http://www.accountingcoach.com/income-statement/explanation/6 [Accessed 15 January 2015]. Bragg, S., 2013. Business ratios and formulas: a comprehensive guide. New York: John Wiley & Sons. CcdConsultants, 2009. Return on Equity Analysis. [Online] Available at: http://www.ccdconsultants.com/calculators/financial-ratios/return-on-equity-calculator-and-interpretation?tab=interpretation [Accessed 15 January 2015]. Dennant, T., 2006. Key Ratios. Business Lending Lead Tutor Article, 1(1), p. 1. Irfanulla, J., 20113. Current Ratio. Accounting Explained, 10(2), pp. 1-2. John, H., 2009. Quality of profits measures your company health. [Online] Available at: http://www.bizjournals.com/washington/stories/2009/11/16/smallb2.html?page=all [Accessed 15 January 2015]. MoneyWeek, 2009. What is net gearing?. [Online] Available at: http://moneyweek.com/videos/what-is-net-gearing/ [Accessed 15 January 2015]. Morning Star, 2010. Efficiency Ratios. [Online] Available at: http://news.morningstar.com/classroom2/course.asp?docId=145093&page=3 [Accessed 15 January 2015]. MyaccoutingCourse, 2014. Quick Ratio. [Online] Available at: http://www.myaccountingcourse.com/financial-ratios/quick-ratio [Accessed 15 January 2015]. Rosemary, P., 2013. What is total asset turnover ratio and how is it calculated?. [Online] Available at: http://bizfinance.about.com/od/financialratios/f/Total_Asset_Turnover.htm [Accessed 15 January 2015]. Siddiqui, S., 2006. Managerial Economics and Financial Analysis. New Delhi: New Age. WA, 2013. Liquidity Ratios. [Online] Available at: http://www.smallbusiness.wa.gov.au/liquidity-ratios [Accessed 15 January 2015]. Wilkinson, J., 2013. Return on Equity Analysis. Strategic CFO, 2(1), pp. 1-3. Read More