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Financial Questions
Should the bank give the requested loan?
If the loan is given, will it be repaid together with interest?
What is the financial institution's remedy if the assumptions about the loan turn out to be wrong?
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Sound Business Characteristics
Adequate liquidity so it can honour short term obligations easily
Run efficiently
Run profitably
The proprietor's stake in the business is high (business is not burdened with too much debt)
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Credit analysis factors
Trend (time series) analysis
Safety buffer
Stress testing
Industry analysis
Economic analysis
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Trend (time series) Analysis
If the business was run profitably for some years, then it may not be unreasonable to assume the trend will continue.
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Safety buffer
If the business has a large margin of safety (between actual sales and break even sales), then some fluctuations in business conditions in the future may not be a cause for concern.
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Stress Testing
The business can be subjected to sensitivity testing.
If the business continues to remain profitable, then the lender can be reasonably certain that the business can withstand future shocks.
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Industry Analysis
What are trends and prospects for the firm's industry? If the industry is growing, then the lender can expect that the firm will also grow.
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Economic Analysis
The lender can analyse trends in the domestic and international economics to gauge the possible impact on the business.
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Remedy's for bad loans
Collateral
Charge on assets
Guarantees
Conditions
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Analysis techniques
Cross-sectional techniques (ratio analysis)
Time series techniques (trend statements, trend of financial ratios, variability measures)
Combination of financial statement information and non-financial statement information
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Ratio Analysis
Liquidity ratios
Efficiency ratios
Profitability ratios
Leverage ratios
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Efficiency ratios
Inventory turnover ratio
Average collection period
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Liquidity ratios
Current ratio
Quick ratio
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Profitability ratio
Gross profit-sales ratio
Net profit-sales ratio
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Leverage ratios
Debt-equity ratio
Interest coverage ratio
Fixed charges coverage ratio
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Trend statements
Expressing the items in a financial statement in an indexed form.
- - Choose one year as the base.
- - Express the values of an item for subsequent years relative to their value in the base year.
(2000 = 56.7, 100; 2001 = 58.4, 103; 2002 = 60.2, 106.17)
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Trend of financial ratios
Computing financial ratios for a series of years for the same firm, and studying their trend.
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Variability Measures
What is not discerned by observing a trend can be known by computing a measure of variability of the ratio
(Max value - Min value)/Mean financial ratio
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