I am sure some of us who bother reading financial statement of banks may have come in touch with the phrase “Cost To Income Ratio”. I did and I was a bit confused at first till I decided to dig in.
Apparently, Cost to Income Ratio (CIR) is similar to the Operating Profit Margin or in simple terms the ratio of your operating profit to the revenue that a company makes. It is used to determine how efficiently a company is being run and how it earns its own organic income. Whilst this is a broader definition, banks do have a some what different way at presenting their financial statements. For example, for most industries to determine what is operating profit they will deduct cost of sales from revenues to arrive at Gross Profit, after which they deduct Operating Expenses to get operating profits. But banks do not have cost of sales considering that they provide services and do not hold inventories.
Therefore to determine what a banks operating profit is you ail have to first
1. Deduct Interest Expense from Interest Income to arrive at Net Interest Income
2. Add Net Income From Commission and Fees to Net Interest Income
3. Add other income to 2 above to arrive at Operating Income
4. You then deduct the operating expenses from operating income to arrive at the operating profit
5. Operating Expenses include depreciation, salaries, admin and general expenses but does not include loan write-offs
Calculation of Cost To Income Ratio
6. Cost to Income Ratio is therefore the Operating Expenses divided by the Operating Income.