Chapter 2

  1. 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?
  2. 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)
  3. Credit analysis factors
    Trend (time series) analysis 

    Safety buffer

    Stress testing 

    Industry analysis

    Economic analysis
  4. 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.
  5. 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.
  6. 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.
  7. 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.
  8. Economic Analysis
    The lender can analyse trends in the domestic and international economics to gauge the possible impact on the business.
  9. Remedy's for bad loans

    Charge on assets


  10. 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
  11. Ratio Analysis
    Liquidity ratios

    Efficiency ratios

    Profitability ratios

    Leverage ratios
  12. Efficiency ratios
    Inventory turnover ratio

    Average collection period
  13. Liquidity ratios
    Current ratio

    Quick ratio
  14. Profitability ratio
    Gross profit-sales ratio

    Net profit-sales ratio
  15. Leverage ratios
    Debt-equity ratio

    Interest coverage ratio

    Fixed charges coverage ratio
  16. 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)
  17. Trend of financial ratios
    Computing financial ratios for a series of years for the same firm, and studying their trend.
  18. 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
Card Set
Chapter 2
FIN320 - Ch 2