Role Analysis for the Financial Statement

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Appendix 2A

Financial Statement Analysis Using a Return on Equity (ROE) Framework

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Appendix

2A

Financial Statement Analysis Using a Return on Equity (ROE) Framework Between 1992 and 2003 the commercial banking industry experienced a period of record profits. This was quite a change from the late 1980s and early 1990s, when banks were failing in record numbers. Despite record profits, many FIs have areas of weakness and inefficiency that need to be addressed. One way of identifying weaknesses and problem areas is through an analysis of financial statements. In particular, an analysis of selected accounting ratios—ratio analysis—allows FI managers to evaluate the current performance of an FI, the change in an FI’s performance over time (time series analysis of ratios over a period of time), and the performance of an FI relative to competitor FIs (cross-sectional analysis of ratios across a group of FIs). Figure 2A–1 provides a summary of the breakdown of the return on equity (ROE) framework. This framework is similar to the DuPont analysis frequently used by managers of nonfinancial institutions. The ROE framework starts with a frequently used measure of profitability—return on equity (ROE)— and then decomposes ROE to identify strengths and weaknesses in an FI’s

FIGURE 2A–1
Breakdown of ROE into Various Financial Ratios
ROA Net Income Total Assets Profit Margin Net Income Total Operating Income

Interest Expense Total Operating Income

Provision for Loan Losses Total Operating Income

ROE Net Income Total Equity Capital

Noninterest Expense Total Operating Income

Income Taxes Total Operating Income

Asset Utilization Total Operating Income Total Assets

Interest Income Total Assets (components)

Equity Multiplier Total Assets Total Equity Capital

Noninterest Income Total Assets (components)

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Appendix 2A

Financial Statement Analysis Using a Return on Equity (ROE) Framework

TABLE 2A–1
Role of ROE, ROA, EM, PM,...
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