Bank ratio analysis uses mathematical formulas to evaluate a bank’s financial statements, including liquidity, asset turnover, and leverage ratios. Liquidity ratios, such as the current and cash ratios, assess a bank’s ability to pay liabilities. Asset turnover ratios measure bank efficiency, while leverage ratios evaluate debt usage. Investors can use ratio analysis to determine whether to invest in a bank’s stock.
Bank ratio analysis involves the application of mathematical formulas to bank-specific information. The bank’s financial statements are usually the main source of the necessary data. Liquidity and asset turnover ratios are more applicable here, along with some leverage ratios thrown into the mix. Ratios allow interested parties to assess the financial viability of a bank. Investors can also use the data obtained from a bank’s ratio analysis to determine whether they want the bank’s stock as an investment vehicle.
Liquidity ratios are often the most common ratios applied to a bank’s financial data. These ratios provide benchmarks for evaluating how well a bank maintains its internal finances. The current ratio divides current assets by current liabilities. A high current ratio indicates less risk in the bank since the institution has more assets to pay the liabilities. Liabilities include customer deposits and any other claims against the bank’s assets.
An alternative liquidity ratio is the cash ratio, which is also quite applicable in the analysis of a bank’s ratio. This formula divides the bank’s available cash plus marketable securities by its current liabilities. This ratio indicates the amount of liquid assets the company has to pay money owed to other parties.
Asset turnover ratios, while slightly less common in terms of a bank’s ratio analysis, can be a primary tool here. Banks use this tool by dividing total income by total assets. The result is an efficiency figure that assesses how well the bank uses its own assets to earn money for the bank and its stakeholders. As is common with most asset turnover ratios, a higher result is usually better, as it demonstrates better overall bank efficiency.
Financial leverage ratios are also an informative accounting tool for measuring the efficiency of a bank’s operations. The two most common formulas include the debt ratio and the debt ratio. Total debt divided by total assets comprises the debt ratio. This indicates how much debt the bank uses to pay off the assets. A higher figure here may be a sign that the bank has over-leveraged its assets with foreign debt.
Debt to equity replaces total assets as the denominator with total equity in a bank’s ratio analysis. The results indicate how well the bank uses outside investment to buy and use assets. Publicly traded banks are the most common users of this relationship. Over leverage is not an issue here; however, shareholder funds are not used properly.
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