Industry-specific Ratios

There is no universally accepted definition or classification of ratios. Ratios indicate a company’s performance and value, but their significance varies by industry. Industry-specific ratios, like same-store sales changes in retail, help distinguish growth sources. In regulated sectors like banking, specific regulatory ratios, like liquidity and capital adequacy, reflect compliance and risk exposure. Industry-specific metrics are crucial, especially in early-stage industries with unprofitable companies.

Exhibit 2 presents some examples of industry-specific ratios.

$$ \textbf{Exhibit2: Common Industry-Specific Ratios} $$

$$ \begin{array}{l|c}
\textbf{Business Risk Ratio} & \text{Formula} \\ \hline
{\text{Coefficient of variation of operating income} } & \frac {\text{Standard deviation of operating income}}{\text{Average operating income}} \\ \hline
{\text{Coefficient of variation of net income}} & \frac {\text{Standard deviation of net income}}{\text{Average net income}} \\ \hline
{\text{Coefficient of variation of revenues}} & \frac {\text{Standard deviation of revenue}}{\text{Average revenue}} \end{array} $$

Financial Sector Ratios

$$ \begin{array}{l|c}
\textbf{Financial Sector Ratios} & \text{Formula} \\ \hline
\text{Capital adequacy} & \frac {\text{Various components of capital}}{\text{Various measures}^\ast} \\ \hline
\text{Monetary reserve requirement} & \frac {\text{Reserves held at central bank}}{\text{Specified deposit liabilities}} \\ \hline
\text{Liquid asset requirement} & \frac {\text{Approved “readily marketable” securities}}{\text{Specified deposit liabilities}} \\ \hline
\text{Net interest margin} & \frac {\text{Net interest income}}{\text{Total interest-earning assets}}
\end{array} $$

\(\text{Various measures}^\ast\)=Various measures such as market risk, risk-weighted assets, or level of operational risk assumed

Retail ratios

$$ \begin{array}{l|c}
\textbf{Retail ratio} & \text{Formula} \\ \hline
\text{Comparable (or same) store sales} & {\text{Average revenue growth year over} \\ \text{year for stores open in both periods} }\\ \hline
\text{Sales per square meter (or square foot)} & \frac {\text{Revenue}}{\text{Total retail space in square meters (feet)}}
\end{array} $$

Service Industry Ratios

$$ \begin{array}{l|c}
\textbf{Service industry} & \text{Formula} \\ \hline
\text{Revenue per employee} & \frac {\text{Revenue}}{\text{Total number of employees}} \\ \hline
\text{Net income per employee} & \frac {\text{Net income}}{\text{Total number of employees}} \\
\end{array} $$

Hotel Industry Ratios

$$ \begin{array}{l|c}
\textbf{Hotel Industry} & \text{Formula} \\ \hline
\text{Average daily rate} & \frac {\text{Revenue}}{\text{Number of rooms sold}} \\ \hline
\text{Occupancy rate} & \frac {\text{Number of rooms sold}}{\text{Number of rooms available}}
\end{array} $$

Relationship or Subscription-Based Firms Ratios

$$ \begin{array}{l|c}
{\textbf{Relationship or Subscription-Based} \\ \textbf{Firms}} & \text{Formula} \\ \hline
\text{Average revenue per user (ARPU)} & \frac {\text{Revenue}}{\text{Average number of users or subscribers} }
\end{array} $$

Question

What do liquidity and cash reserve ratios primarily indicate in the banking sector?

1. Liquidity and cash reserve ratios reflect the efficiency of loan origination and credit risk assessment.
2. Liquidity and cash reserve ratios provide insights into a bank’s liquidity and compliance with monetary and regulatory requirements.
3. Liquidity and cash reserve ratios measure a bank’s profitability and return on equity.

Solution

B is correct. Liquidity and cash reserve ratios in the banking sector primarily indicate a bank’s liquidity position and adherence to monetary and regulatory requirements. These ratios assess the bank’s ability to meet short-term obligations and maintain financial stability.