Appendix 2A Financial Statement Analysis Using a Return on Equity (ROE) Framework 1 Appendix 2A Financial Statement Analysis Using a Return on Equity (ROE) Framework Between 1992 and 2000 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 identify- ing 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 per- formance 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 Net Income Total Equity Capital Net Income Total Assets Total Assets Total Equity Capital Net Income Total Operating Income Total Operating Income Total Assets Interest Expense Total Operating Income Income Taxes Total Operating Income Interest Income Total Assets (components) Noninterest Income Total Assets (components) ROE ROA Profit Margin Equity Multiplier Asset Utilization Provision for Loan Losses Total Operating Income Noninterest Expense Total Operating Income