Chase bank is now the third bank to go under receivership in the last one year. It was ranked among the best in different categories. They even managed to get a loan from African Bank as they were planning to expand. But how did they escape the eyes of the analysts? Their financials are full warnings signals since 2012.
Here are Some of the ways to prove it
When a company gives an unexpected earnings report at the fourth quarter, it is an indication of malpractice. The company may be over-reporting or under-reporting profits in the first three quarters of the year. Chase bank did that in the last financial year as seen in the table below. March report which was the performance of the previous quarter indicates clearly that they practiced this surprise.
|Quarters||Sep 14||Dec 14||Mar 15||Jun 15||Sep 15|
This is the most massaged item by the management in the income statement. Studies have shown revenue recognition is a recurring source of accounting manipulation and even outright fraud.
When analyzing if Chase Bank has manipulated revenue, examine its accounting policies notes for a company’s revenue recognition policies. Although KCB and Chase bank use effective rate to recognize revenue, little can be done to prove if they had followed the said accounting policy because of minimal disclosure.
Effective interest rate is the rate that discounts the estimated future cash payments and receipts through the expected life of the financial asset or financial liability. When calculating effective interest rate, they estimated future cash-flows considering all contractual terms of the financial instrument, but not future credit losses. Other revenues earned include fees and commission income from a diverse range of services to its customers
Revenue growth in the industry relationships
Comparison of Chase bank’s revenue growth with KCB and Equity banks, which are its competitors shows that its growth was way above the rest. When a company’s revenue growth is out of line with its competitors in its industry then the analyst can question the out performance. The two banks are better in the market and such kind of performance raises questions. It might be an indication of accounting management.
|Net revenue growth||2013-2014|
Operating margins out of line with competitors
Although banks sales are quite different from other sectors, the indication of their performance here speaks volumes. When we compare Chase bank’s operating revenue and net revenue we realize that it is somehow lower than that of other competitors. The disparity may indicate a warning sign. It might be either superior management ability or the presence of accounting manipulations.
|Net Income/Net sale||2015||2014||2013|
Cash flows and net income
Management manipulates either cash flows or net income but net income must be realized in cash if a company is to remain stable. If net income is higher than cash from operations, then there might be an aggressive accrual accounting policies that shift current expenses to next periods.
Increasing earnings in the presence of declining cash generated by operations might signal accounting irregularities.
Chase bank net income has always been higher than its cash flows in the previous period except 2014 report. The increase of cash flow is abnormal, which is an indication of irregularity.
Cash from operations divided by net income
When the ratio is consistently below 1.0 or has declined repeatedly, there may be problems in the company’s accrual accounts. From Chase Bank’s financials the ration was operating below 1 until 2014 when it suddenly increased to 2.77. 2015 report is not yet out but that shows a negative signal. It’s an indication of a sudden change in accrual practices. This is used to manipulate statements.
|Cash Operation/Net Income||(0.64)||0.54||2.77|
Chase bank has in the past indicated that it had miscellaneous expenses of Sh 95 million. This income is periodic as it does not appear in all financial statements. This may creates room to manipulate financials to give a certain desired performance. It is always advisable that all income and especially of organizations such as banks to be disclosed.
Chase bank in its financial statements has classified some expenses as ‘other expenses’ and the value is a high of Sh 400 million. This has not been well explained in the notes. It may appear once in awhile and may always be left unquestioned by analysts. This may be used by management to smoothen financial.
Capitalization policies and deferred costs
If you examine the chase bank accounting policy notes and compare it with the company’s policy within the industry, less can be concluded. When the company is the only one capitalizing certain costs while other industry participants treat them as expenses, a red flag is raised. This again may not be well applicable. Chase bank has provided minimal disclosure on how they have followed this policy in the past. It has extensively described the international standard requirement but not what they have practiced. Failure to disclose in detail about such only raises the red flag.
Depreciation methods and useful lives
Little has been disclosed on Chase Bank’s depreciation methods and useful lives. Their practices are what others in the same industry are practicing. We can’t analyze how they may have used this to manipulate accounts. Depreciation methods and the useful lives selected can greatly influence profitability. An investor should compare a company’s policies with those of its peers to determine whether it is particularly lenient in its effects on earnings.
We have a lot of banks and insurance companies that are operating under false status. People are losing their jobs and others their investments as this trend continues. What analyst can do is to look at these companies’ financials and determine which the next is. It’s the responsibility of analyst to save the public and expose the greed.
By Gathathai Mwangi