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Ratio analysis of a bank involves the application of mathematical formulas to specific information from the institution. The bank’s financial statements are typically the primary source for the requisite data. Liquidity and asset turnover ratios are most applicable here, along with a few leverage ratios added to the mix. The ratios allow a stakeholder to assess the financial viability of a bank. Investors can also use the data gleaned from the ratio analysis of a bank to determine if they desire 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 assessing how well a bank maintains its internal finances. The current ratio divides current assets by current liabilities. A high current ratio indicates lower risk in the bank as the institution has more assets by which to pay off liabilities. Liabilities include customer deposits and any other claim against the bank’s assets.
An alternate liquidity ratio is the cash ratio, which is also quite applicable in the ratio analysis of a bank. This formula divides the bank's cash on hand plus marketable securities by its current liabilities. This ratio indicates how much liquid assets the company has for paying off monies owed to other parties.
Asset turnover ratios, while a bit less common in terms of ratio analysis of a bank, may be a primary tool here. Banks use this tool by dividing total revenue by total assets. The result is an efficiency figure that assesses how well the bank uses owned assets to make money for the bank and its invested stakeholders. As is common with most asset turnover ratios, a higher result is typically better as it proves better overall efficiency from the bank.
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 debt-to-equity ratio. Total debt divided by total assets comprises the debt ratio. This indicates how much debt the bank uses to pay for assets. A higher figure here can be a sign that the bank has overleveraged its assets with external debt.
Debt-to-equity replaces total assets as the denominator with total equity in ratio analysis of a bank. The results indicate how well the bank uses external investments to purchase and use assets. Publicly held banks are the most common users of this ratio. Overleveraging is not a problem here; not using stockholder funds appropriately is, however.