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1、Credit Analysis,1,A Framework for Credit Analysis,I.Risk AssessmentII.The Clients Funding NeedsIII.Loan Structuring IV.Loan Management,Credit Analysis,2,I.Risk Assessment,Monitoring the Economic EnvironmentAnalyzing Industry ConditionsAssessing a Clients Marketing ManagementAppraising the Clients Op
2、erations ManagementEvaluating Management Capabilities and CharacterAnalyzing the Borrowers Financial Management,Credit Analysis,3,Monitoring the Economic Environment,Much of the risk associated with a loan is due to broad economic forces as shown on the next slideLender must manage its exposure to c
3、ertain types of businessesLender may have to curtail lending,even to businesses with a good track record,in periods of economic adversityNecessary to monitor the current and forecasted economic environment,Credit Analysis,4,The Economic Environment-Cont.,Key elements of the economyEconomic growth-th
4、e business cycleInflation ratesInterest rates-the level,term structure and risk structureGovernment-political trends and current fiscal and monetary policiesInternational relationships-balance of payments,currency value,international markets,Credit Analysis,5,The Economic Environment-Cont.,It is imp
5、ortant for the lending officer to keep on top of broad economic conditions because of their potential impact on the banks clients and the quality of the officers loan portfolio,Credit Analysis,6,Analyzing Industry Conditions,A borrowers financial performance depends on:Current conditions and prospec
6、ts for its industryHow well the company is positioned relative to the competition?It is necessary to understand both the risks and opportunities for the major industry sectors in the banks marketDetermine two factors:Are the industrys prospects attractive?Which types of firms are most likely to succ
7、eed in the industry?,Credit Analysis,7,Analyzing Industry Conditions,Banks now create portfolio management groupsMonitor industry concentrations in the banks loan portfolio Determine future prospects for key industriesSet limits on the maximum exposure the bank will permit for an industry or specifi
8、c borrowerRisk classification systems-used to assign a numeric risk rating to all borrowers or loan requests.Industry conditions form part of this risk rating.,Credit Analysis,8,Factors affecting Industry Conditions,Michael Porters ModelEase of EntryAvailability of Substitute ProductsBargaining powe
9、r of buyers and suppliersCompetitive rivalry.Rivalry tends to be greatest when there are numerous companies producing largely undifferentiated products or services.Dependence on other industries,Credit Analysis,9,Assessing a Clients Marketing,Marketing is a critical factor for most borrowers,especia
10、lly“start-ups”,those entering a new business or facing tough competitionFirm should have a plan which covers:Product PoliciesPrice PoliciesPromotionPersonal Selling ActivitiesDistribution Policies,Credit Analysis,10,Appraising the Clients Operations Management,Operations management-the set of activi
11、ties required to transform inputs such as raw material and labour into the final product.Major components of operations include:Quality-value for moneyProcess Design-technology,plant layoutFacilities Planning and SchedulingInventory Management-how much is necessary to carry?Employee management,Credi
12、t Analysis,11,Evaluating Management Capabilities and Character,Determine the experience and skills of key principalsThis includes technical knowledge,contacts,resources in marketing,operations and finance plus skill in managing and motivating othersAssess managements character:integrity,financial co
13、nservatism and respect for creditors,Credit Analysis,12,Analyzing the Borrowers Financial Management,Strong financial management is an essential ingredient for successFinancial capacity is the composite of management policies and practices in several areas:Is there adequate liquidity?The firms relat
14、ionships with trade creditors,lenders and investorsThe equity capital contributed by the ownersThe extent of the owners withdrawals,Credit Analysis,13,Borrowers Financial Management contd,Calculate key financial ratios1.Profitability ratios2.Asset utilization ratios3.Financial capacity testsWhich ra
15、tios to calculate will vary with the the industry and type of business(example-service or manufacturing),Credit Analysis,14,Profitability Ratios,Profit Margin:Net profit after tax/net sales.Gross Profit margin:The portion of revenues remaining after the cost of sales.(Net Sales-Cost of Sales)/Net Sa
16、lesSales Growth:Measured over time.Usually expressed as a%growth per year.Return on Assets:Net Profit/Total Assets.This may be distorted due to the age of the firms assets.,Credit Analysis,15,Profitability Ratios,Return on Equity=Net Profit/Total EquityThis measures the rate of return on the capital
17、 provided by equity investors.Equity includes common stock,retained earnings,and minority shareholders interestBanks normally require an agreement from the owners that equity funds will not be withdrawn without the banks prior permission,Credit Analysis,16,Asset Management Ratios,Turnover of Current
18、 Assets.Days of inventory=Inventory/(Cost of Sales365 days).This shows how carefully management is controlling its investment in inventory.Cost of sales is used to ensure that both goods sold and inventories are compared on the same basis,namely at the cost of purchase or production.,Credit Analysis
19、,17,Asset Management Ratios,Collection period for Receivables=Accounts Receivable/(Net Credit sales365)Tells us how quickly Accounts Receivables are collectedIn addition,the lender should obtain an aging schedule which classifies Accounts Receivable by how long they have been outstanding For example
20、,if the business sells on net 30 days then most receivables should be no longer than 30 days,Credit Analysis,18,Typical Aged Accounts Receivable Schedule,0-30 days31-6061-9090+Grade A Company Inc12,000A Good Bet&Associates23,000Not So Bad Co.4,500A Poor Deal Inc.6,000Fly by Night Ltd.999,Credit Anal
21、ysis,19,Asset Management ratio-contd,If a large number of customers have not paid for 40 or 50 days or longer,then the company may be lax in collecting overdue accounts or has extended credit to customers who have difficulty paying.Older receivables may indicate that the quality of the receivables i
22、s suspect.This means that the bank may not be able to collect all of its receivables if the borrowers assets needed to be liquidated.,Credit Analysis,20,Financial Capacity Ratios,The firm must be sufficiently liquid to meet its recurring commitments and have a debt structure that can be serviced fro
23、m both its profits and its cash flowsLiquidity Measures:Current Ratio=Current Assets/Current LiabilitiesIs a good measure of solvency as it indicates the extent to which claims of short-term creditors can be covered by liquid assets,Credit Analysis,21,Financial Capacity Ratios,Quick ratio=(Cash+Shor
24、t Term securities+receivables)/Current LiabilitiesShows the most liquid assets which can be liquidated to meet short-term obligations,Credit Analysis,22,Financial Capacity Ratios,Debt Ratios tell us how much financial leverage the firm has.Higher leverage increases the risk of the loan and whether t
25、he firm will be able to service its interest and principal payments.The amount of equity invested signals the commitment of the major shareholders to the business.,Credit Analysis,23,Financial Capacity Ratios Continued,Debt to Assets=(Current Liabilities+Long-term debt)Assets*Measures the proportion
26、 of assets financed by other peoples money including the bank.Debt to Equity=(Current Liabilities+long-term debt)(Total equity capital+postponed shareholders loans)*Measures the debt relative to the investment of the owners.Interest Coverage Ratio=(Earnings before interest and taxes)/interest.*This
27、measures a firms debt-worthiness and its ability to meet interest payments out of recurring profit.,Credit Analysis,24,Summary of Financial Ratio Analysis,Profitability Ratios:Net Profit MarginNet Profit/SalesGross Profit MarginGross Profit/SalesReturn on AssetsNet Profit/SalesReturn on EquityNet Pr
28、ofit/EquityAsset Management Ratios:Total Assets TurnoverNet Sales/Total AssetsFixed Assets TurnoverNet Sales/Net Fixed AssetsDays of InventoryInventory/(Cost of Sales365),Credit Analysis,25,Financial Ratios Continued,Accounts ReceivableCollection PeriodAccounts Receivable(Average Daily Sales)Financi
29、al Capacity Ratios:Current ratioCurrent Assets/Current LiabilitiesQuick ratio(Current Assets less inventory less prepaid expenses)/Current liabilities,Credit Analysis,26,Financial Ratios Continued,Financial Capacity Ratios(Continued):Accounts payable payment period=Accounts payable/Average daily pur
30、chasesDebt to assets ratio=Total Debt/Total AssetsInterest Coverage=(Earnings before interest and taxes)Interest,Credit Analysis,27,Cash Flow Analysis,The purpose of a risk assessment is to judge the companys ability to service its obligations to the bank.A borrowers repayment capacity is primarily
31、determined by the cash flows that the business generatesThe major sources and uses of cash in the business must be identified to predict future cash flowsStatement of changes in financial position are provided as part of the cash flow statements Tells where the cash is coming from and where it is be
32、ing used:operating,investing and financing activities,Credit Analysis,28,II.The Clients Funding Needs,Estimating Total Financing NeedsIdentifying Non-Bank Sources of Financing,Credit Analysis,29,Estimating Total Financing Needs,A banker has to identify the total funding that the company requires to
33、support its current operations and to carry out its plans for expansion.The major methods of forecasting a firms financial needsCash Flow budgetsPro forma financial statementsThe loan facility must be set at a level that is both realistic for the companys needs but is not excessive relative to the a
34、vailable cash flows,Credit Analysis,30,Financing Needs,Financial forecasts must be prepared by management or an outside accountant and the banker can only assess the reasonableness of the forecasts.Provides both the amount and timing of the firms needsHelps the banker better analyze the risks associ
35、ated with a loan request.Sensitivity analysis should be done where the forecasts are prepared using different assumptions about future events,Credit Analysis,31,Financing Needs,Bankers too often see loan applications only after financial needs have become immediate and urgent.Financial forecasts pro
36、vide the bank with checkpoints for monitoring a borrowers progress and performance.An unanticipated need is not necessarily bad.It could also indicate that the firm has found a new business opportunity to pursue.,Credit Analysis,32,Cash Flow Forecasts,Cash flow forecast estimates when and in what am
37、ounts cash will flow in and out of the businessCash budgets are useful for short term forecasts and for those companies with seasonal sales and production cyclesPrepare Cash Receipts based on projected sales and then prepare cash outlays which are closely linked to the sales forecast.,Credit Analysi
38、s,33,Sample Cash Budget,Credit Analysis,34,Projected Financial Statements,Approximate forecasts can be developed by applying the companys existing balance sheet and income statement ratios to estimates of future sales volumes.Extend forecasts several years into the futureForecasted Income Statements
39、Are usually the starting point in developing a pro forma statementMany variables such as inventories&account s receivables move closely with sales,Credit Analysis,35,Projected Financial Statements,Start with forecasting the estimated sales growth rate.Raw material costs,labour expenses and productio
40、n supplies as a percentage of sales are forecasted to remain at current levels.Usually the balance sheet is more difficult to forecast than an income statementEstimates are required and may not be related to a single key variable such as the sales figure,Credit Analysis,36,Projected Financial Statem
41、ents,Accounts receivable and inventory are tied to sales Estimate the accounts receivable balance based on the past collection experienceEstimate inventories based on the typical inventory levels.Estimate the planned purchase of new plant and equipment less depreciationAccounts payable forecast shou
42、ld incorporate the companys planned purchases of raw materials and its payment practices,Credit Analysis,37,Projected Financial Statements,Cash and Notes payable should be adjusted to balance both sides of the balance sheet.Cash account is set at an amount that the company believes to be a reasonabl
43、e working balance.Once the cash account is forecasted,the bank loan payable can be calculated to find the amount that makes the balance sheet balance.This is known as the“plug”figure.This balancing figure represents the clients funding requirement to support the forecasted level of assets.,Credit An
44、alysis,38,Projected Financial Statements,Forecasts should be constructed with different basic assumptions.Sensitivity analysis could test the following:1.Slowdown in the collection of accounts receivable2.Decline in inventory turnover rate3.Unanticipated expansion of fixed assets4.Higher expenses th
45、an planned5.Lower sales levels than predicted6.Trade creditors demanding faster payment,Credit Analysis,39,Identifying Non-Bank Sources of Financing,Three broad sources of funds are available to the firm:1.Funds generated by the firm by increasing the working capita.lA.Shorten credit terms and incre
46、ase the quality of customers receiving credit(use better screening).B.Reduce company inventory levels and slow paymentof account payables(where possible)C.Improve financial planning-cash flow budgeting,Credit Analysis,40,Identifying Non-Bank Sources of Financing,2.External business sources-Personal
47、AssetsFriends,family and employees-“love money”Informal Investors-private individualsFactoring-a firm that acts as the credit and collections departmentLeasingFranchising or Venture CapitalOther term lenders-eg.GE CapitalPublic Equity Markets,Credit Analysis,41,Identifying Non-Bank Sources of Financ
48、ing,3.External government SourcesGrantsForgivable LoansDirect loansGovernment GuaranteesTax breaksDirect equity investments in the firm,Credit Analysis,42,Part III.Loan Structuring,1.Identifying the Amount and Form of Bank Financing2.Lending and the Legal Environment3.Securing the Loan4.Lending and
49、Environmental Law5.Pricing the Loan 6.Designing the loan agreement and loan covenants,Credit Analysis,43,The Amount and Form of Bank Financing,The Initial Screen-Is the deal“bankable?”.Does it have acceptable risks relative to the return?Is the return adequate to compensate for the risks accumulated
50、 and the cost of servicing the account.Banks are in the business of granting loans that they consider to be relatively low risk.Prepare a list of pros and cons Turning down the loan should include a frank discussion of the companys problems and options,Credit Analysis,44,The Amount and Form of Bank
