CHAPTER – III
ANALYSIS OF PROFITAIBILITY
4. Analysis of the Profitability of the Banks Under Study:
An attempt has also been made to judge the profitability of the selected UCBs through ratio. The researcher has used the following ratio:
1. Operating Profit Margin Ratio (OPMR).
2. Interest Earned To Total Funds Ratio (IETFR).
3. Interest Paid To Total Funds Ratio (IPTFR).
4. Return on Total Funds Ratio (RTFR).
5. Return on Capital Employed Ratio (RCER).
6. Cost of External Funds Ratio (CEFR).
7. Net Profit to Total Assets Ratio (NPTAR).
Operating Profit Margin Ratio (OPMR)
Operating profit margin ratio is an important ratio measuring the profitability of the UCBs. There ratio reflect the operating efficiency of the UCBs. It also indicates the efficiency of the management to earn a higher margin per rupee of income. This ratio is called operating profit ratio. It establishes the relationship between operating profit and operating income. This ratio is also known as Gross Margin Ratio and is calculated as follows.
Operating profit margin ratio = Operating Profit/Operating Income*100
Where operating profit =operating income-operating expenses. This ratio indicates the profitability of business i.e. operating efficiency of a bank. A higher the operating margin ratio, that better would be the
operational efficiency of the bank. A higher operating margin ratio means a bank has been able not only to increase its operating income but also been able to cut down its operating expense. In short a higher ratio is a sign of good management while a low ratio may suggest decline profitability.
Operating Income= Interest received on government securities, investment, loans and advances, bills discounted, commission, exchange and brokerage plus other revenue income.
Operating Expense= Interest paid on deposits and borrowing plus other general expenses like salaries, allowances, provident fund directors fees, rent and taxes, insurances, lighting, law charges, audit fees, depreciation, stationery, printing and advertisement expenses and other expenses.
Interest Earned to Total Fund Ratio:
Interest earned to total fund is an important ratio of measuring the efficiency of management regarding employing its funds in an optimum manner. This ratio indicates the interest earned on each rupee of total funds employed. As interest earned is a major source of income in the UCBs. They should try to earn maximum returns on employed funds. But at the same time, they should make safer advances and try to reduce the proportion of NPA. They should also invest their funds in Government securities. As interest earned has direct effect on profitability of the UCBs, the management should be efficient in taking decision about how much funds should be advanced, how much should be invested and how much should be remain as liquid assets so that optimum level of liquidity can be maintained. The ratio is calculated by using following equation.
Interest Earned to Total Funds Ratio=Interest Earned/total funds*100
Interest Earned= Interest on loans and advances, plus interest on Govt.
securities plus interest on other securities and income from bills discounted.
Total Funds= share capital plus reserve and surplus long term and short term deposits plus Borrowings and current liabilities.
This ratio measures the profitability of investments which reflects managerial efficiency. The higher the ratio indicates efficient utilization of funds while decreasing trend of this ratio marks the failure of UCBs in optimum utilization of funds. The basic objective of this ratio is to measure the effectiveness of the use of these funds A decreasing trend, indicates poor policy of advancing loans in the UCBs.
Interest Paid to Total Fund Ratio:
Interest paid to total funds ratio is an important ratio for measuring the profitability of the UCBs. In banking sector interest paid occupies a major portion of total operating cost and affects profitability. As each fund has its own procurement cost, if interest paid is higher, it reduce profitability and indicates failure of management in obtaining low cost deposits. The bank should always try to get maximum deposits at a lower cost and should advance at a higher rate, because difference between cost of deposits and return on advance is the profit margin for bank. Interest paid is always compared with interest earned. There should be enough margins between these two variables i.e. the growth of interest paid should be less
than interest earned so that the bank can maintains its profit. This ratio is calculated as follows.
Interest Paid to Total Fund Ratio= Interest Paid/Total Funds*100 Interest Paid= interest paid on deposits and borrowings.
Total Funds= share capital plus reserve and surplus long term and short term deposits plus Borrowings and current liabilities.
This ratio indicates the interest paid on each rupee of total funds obtained and also shows obligation of banks towards their depositors. The higher the ratio indicates inefficiency of management in obtaining low cost deposits. Besides it also indicates decreasing faith of public in the UCBs. Similarly, decreasing the ratio indicates efficiency of bank in obtaining low cost deposits but unwillingness investments by the investors.
Return on Total Fund Ratio:
Profitability can also be measured by establishing relationship between operating profit and total assets. Return on total funds is also one of the important measures of profitability. It measures the profitability of all financial resources invested in the assets of a bank. It also indicates efficiency of the management in advancing loans and investments which investing in the most profitable sector so that the bank can earn large amount of interest. In the banking units, profit depends upon efficiency of the management in utilizing its funds. The more efficient use of funds, the more profitability assured. This ratio has been calculated by dividing the operating profit by total funds invested or total assets in the banking sector.
Return on Total Funds Ratio= Operating Profit/Total Funds*100 Operating Profit= Operating Income less Operating Expenses
Total Funds= Total Assets.
This ratio measures the profitability of investments, which reflects managerial efficiency. It indicates the capacity to earn operating profit per rupee of total funds. The higher the ratio, the better is the profit earning capacity of the firm or vice versa. An increasing trend of this ratio indicates that the bank is able to earn more income by utilizing its funds in a profitable manner. But a decreasing trend indicates the bank’s failure in managing funds. The basic objective of this ratio is to measure the effectiveness of the use of funds.
Return on Capital Employed Ratio:
The primary objective of making investment in any business is to obtain adequate return on capital invested. Therefore, to measure the overall profitability of the bank, it is essential to compare operating profit with capital employed. It is also called “Return on Investment” (ROI) In relation to banking sector return on capital employed is an important ratio for measuring the efficiency of management in utilization of funds supplied by depositors and owners. It expresses profitability on overall investment viz. total resources utilized by the bank. The capital employed is equal to owner’s funds plus long-term deposits. Thus capital employed basis provide a test of profitability related to the long-term funds. The formula used is as follows:
Return on Capital Employed Ratio= Operating Profit/Capital Employed*100
Operating profit = operating income less operating expenses Capital Employed = Owners Funds plus long- term deposits.
The higher the ratio, more efficiency of the management in utilizing funds entrusted to them and better is the financial position of bank. This ratio indicates the earning power of the bank on each rupee invested. This ratio is useful for management to take investment decisions in form of deposits in a particular bank and judging the prospects or stability of the bank.
Cost of External Funds Ratio:
The cost of external funds ratio is an important measure of evaluating the cost of obtaining external funds. As each deposit has its own cost, a bank has to obtain funds at a minimum cost and to advance at higher rate of interest. It spread between interest earned and interest paid is the only profit margin of bank. The bank tries to obtain low cost funds as compared to high cost of fund. This ratio is calculated as under,:
Cost of External funds Ratio=Interest Paid/External Funds*100 Interest paid= Interest Paid on Deposits and Borrowing.
External Funds= Deposits plus Borrowings.
The higher the rate of this ratio indicates the inefficiency of management in obtaining funds. While lower the rate of this ratio marked the efficiency of management in obtaining funds at low cost.
Net Profit to Total Assets Ratio
Net profit to total assets ratio measures overall profitability of the UCBs. This ratio is an advancement of "Return on Total Funds Ratio"
Return on total funds ratio measures the operating efficiency of the management in utilizing funds, while net profit to total assets ratio reveals net earning of the UCBs by utilizing funds. It gives earning per rupee of funds invested. Higher earnings indicate control of management on its operating cost or efficient utilization of funds. The formula for calculation of this ratio is as follows:
Net Profit to Total Assets Ratio = Net Profit/ Total Assets *100
Net Profit = Operating plus non operating income less non operating expenses and provisions.
Total Assets =Total Funds.
5. Analysis of Profitability of the Units Under Study