Finacial Analysis

1 CHAPTER ONE

1.1 INTRODUCTION

1.1.1 BACKGROUND OF THE RESEARCH

Financial information analysis refers to the process and technique used to identify and extract the critical information contained in the financial statements and any supporting documentation (O’Regan, 2006). Information contained in these statements is critical for analysis and interpretation of the financial performance of a given entity. However, the financial statements are not sufficient for decision-making as they are and further analysis is needed before they can be relied on. Financial analysis enhances this by identifying trends through ratio analysis, which then allow the user to draw meaningful conclusions.

Financial information is important especially to the shareholders of an entity. They expect a return on their investments measured by the profitability of the company and could take the form of dividends, bonus issues, rights issues and exercising options and warrants.

Banks are the barometers as it were of the financial health of most economies in the world. They act as financial intermediaries between lenders of funds and borrowers providing credit facilities, safety deposits and consultancy services to all those involved. It is from this basis that this report is developed using Equity Bank Limited, one of the fastest growing commercial banks in Kenya.

The Kenyan banking industry has grown tremendously in the recent past improving access to financial services that was seen by many as a major problem in their attempts to do business. Though it is true that credit in formal banking institutions has grown steadily over the years, the same was not available to the people in the rural areas. This therefore gave Equity Bank Limited an opportunity of providing microfinance services to the poor in rural areas. This strategy was a boost to the bank and managed to snatch a portion of the market from other commercial banks that are located in cities and major towns (Mutua and Oyugi, 2006).

In respect of this awakening call, most of the commercial banks have decided to follow Equity Bank’s strategy and have moved to the rural areas. An example of this is Barclays Bank that decided to set up branches in rural areas like Kawangware unlike previously where they were concentrated in major cities like Nairobi.

This research gives an insight of how a small micro-finance institution can rise through the ranks to become one of the biggest commercial banks. The reason for choosing this topic is the rapid growth of Equity Bank Limited over a short period that calls for critical analysis of its basis and sustainability.

Some of the key areas discussed with regard to the topic were:

• Importance of financial ratios.

• Limitations of financial ratios.

• Applications and analysis of financial ratios.

• Trend analysis of Equity Bank’s financial performance.

1.1.2 AIMS AND OBJECTIVES

There is the need to establish financial performance of a company, which reflects the company’s corporate governance and leadership. The analysis of a company’s financial position can be derived from financial ratios that are based on the financial statements of the company.

The hypotheses used as regards the research topic were:

 The bank’s expansion strategy is unlikely to be sustained over the next 5 years.

пЃ¶ The strong performance is largely due to incentives from the government.

пЃ¶ The bank is not following the corporate governance code that may not be reflected in its financial statements.

The aims and objectives as derived from the hypotheses above were:

пЃ¶ To assess the financial ratios of Equity Bank Limited over a period of 6 years in order to establish the continued sustainability of their expansion.

пЃ¶ To establish whether the financial reporting of Equity Bank supports its corporate governance code.

 To establish the basis of the Bank’s rapid growth in the process checking whether it is due to incentives from the government.

пЃ¶ To use profitability together with non-performing loans ratios of Equity Bank to establish its position in the industry in terms of growth.

The research questions were:

пÑ"? Does the bank have that ability to sustain the rapid growth, which saw it being acknowledged as a market leader in micro-finance services?

пÑ"? Could Equity Bank be deliberately distorting its financial statements in order to secure some strategic advantage?

пÑ"? What factors have led to the rapid growth of Equity Bank Limited?

пÑ"? Does the bank meet the requirements of the corporate governance code and does it disclose any requirements of the code in financial statements?

пÑ"? What will Equity Bank’s ranking be in five years in the industry?

1.1.3 HISTORICAL BACKGROUND OF EQUITY BANK LIMITED

Equity Bank Limited started its operations in 1984 as Equity Building Society (EBS). EBS was registered on 10th October 1984 under the Building Societies Act (Chapter 489 of the Laws of Kenya). Its establishment was targeted at the majority of Kenyans who were low and medium income earners and had no access to formal banking. It initially focused on offering mortgage services but in the early 1990’s EBS changed its business focus to micro finance services.

In the early 1990’s the bank experienced financial difficulties and in 1992 it almost faced liquidation by the Central Bank of Kenya (CBK). However, due to the bank’s (then EBS) laudable record of creating affordable and easy access of financial services to ordinary Kenyans, CBK opted to apply rational judgment to allow EBS to re-invent itself.

Through the successful and comprehensive implementation of a change management process that concentrated on quality customer service it met the needs of the international standards of best practice. For over 16 years, Equity had survived on a manual system until 2000 when it launched