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CREDIT ANALYSIS

The importance of credit analysis

Credit analysis – is thorough investigation and examination

of related facts and data in order to determine what constitute

the acceptable degree or amount of risk in a particularly case.

Non Financial Factors Of Credit Analysis

1. Antecedent information – is the complete business

records of the individual who manage a business

enterprise.

2. Bank information – in any credit analysis, the seller

will find not only the buyer and those who know him,

but also his bank or banks.

3. Trade information

Financial Factors Of Credit Analysis

1. An examination of the balance sheet and

operating statements details – close analysis of a

balance sheet and operating statements demands a

certain amount of details concerning the major items

when the examination is being made for credit

purposes.

2. Financial statements – the examination of financial

statements is to secure additional information on the

activities of the reporting firm.

3. The economic condition in general and in the

industry – analysis for credit purposes goes beyond

consideration of the financial statement and seeks

information regarding prospects in the industry and

related factors in general.

The Techniques Of Financial Analysis

1. Comparative ratio analysis – the credit man of

financial analyst compute certain ratios from the

customer’s financial statement and compares them

with companies in the same line of business as the

customer in order to draw certain conclusion about

the financial strength of the customer.

2. Trend analysis – this is dynamic type of analysis

wherein computations are made from the costumer’s

financial statements for the current year and are

compared with similar computations for previous

years.

Two Methods In Trend Analysis

a. Ratio trend analysis – which involves the study of

year-to-year changes of convenient ratios from the

financial statements, is used to analyze a customer’s

progress.

b. Horizontal trend analysis – is a study of the

challenge in each of the items in the statement, by

comparing the actual figure from year to year.

Two techniques of calculating percentage changes

i. Simple base-year horizontal trend analysis

Ex. 2008 2009 2010

10,000 12,000 15,000

100% 120% 150%

ii. Progressive base-year horizontal trend analysis

Ex. 2008 2009 2010

100,000 120,000 150,000

100% 120% 125%

3. Where-got-where-gone analysis or application and

sources of funds – this is a method wherein two

successive balance sheets are compared for the

purpose of tracing where funds came from and where

they went.

4. Budget analysis - this method involves an analysis

of its business plans for a definite future period and

how they will affect its finances.

RATIOS

Are mathematical devices used by the credit analyst to aid in

appraisal and comparison of financial statements.

Various ratios used in the analyst of financial statements

A. Balance Sheet Or Liquidity Ratios – is used to

measure the ability of the business firm to meet its

maturing obligations.

1. Current Ratio – current asset divided by current

liabilities.

2. Quick Ratio – this ratio calculated by deducting

inventories from current assets and dividing the

remainder by current liabilities.

3. Acid-Test Ratio – this ratio is defined as cash plus

government securities and other cash equivalent

divided by current liabilities.

4. Receivables to Sales – this ratio consist of net

receivables divided by net credit sales.

5. Cash Velocity – this ratio is cash plus cash

equivalent divided into yearly sales.

6. Cash to Cash Payments – this ratio of cash and

marketable securities to the average daily cash

payments indicates the number of operating days

which the company could sustain without

replenishing its cash and near-cash accounts.

7. Inventory to Working Capital – current assets

minus current liabilities equals working capital.

8. Payable Turnover – this ratio is computed by

dividing the payables, either year end or average of

beginning and ending payables.

9. Inventory Turnover – this is determined by the cost

of sales or by the average inventory.

B. Leverage Ratios – these ratios are the measurement

of the contribution of financing by owners compared

with the financing provided by the creditors of the

firm.

1. Current Liabilities to Net Worth – this is the ratio

of current liabilities to net worth which measure the

amount raised by current debt.

2. Coverage of Fixed Charges – net profit divided by

fixed interest and rental charges equals Coverage of

Fixed Charges.

3. Debt-to-Equity-Ratio – this is computed by dividing

the total debt by net worth or Ownership Funds, such

as preferred stock, common stock, capital surplus,

retained earnings, and any reserve which represent

earmarked surplus.

4. Fixed Assets to Net Worth – this is computed by

dividing the Total Fixed Assets by Net Worth.

5. Debt to Assets Ratio – this is computed by dividing

total debt by total assets.

C. Activity Ratios – are the measurement of the

effectiveness of the employment of resources,

command over which has been financed by the firm.

1. Inventory Turnover – this is computed by dividing

Cost sales by Average Inventory.

2. Total Asset Turnover – this is computed by dividing

sales by total assets.

3. Average Collection Period – a measure of the

accounts receivables turnover is the average

collection period.

4. Fixed-assets Turnover – this is computed by

dividing sales by Fixed Assets.

D. Profitability ratios – the result of a large number of

other policies by the business firm is profitability.

1. Gross Operating margin – this is computed by

dividing gross operating profit by sales.

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CREDIT ANALYSIS The importance of credit analysis Credit analysis – is thorough investigation and examination of related facts and data in order to determine what constitute the acceptable degree or amount of risk in a particularly case. Non Financial Factors Of Credit Analysis 1. Antecedent information – is the complete business records of the individual who manage a business enterprise. 2. Bank information – in any credit analysis, the seller will find not only the buyer and those who know him, but also his bank or banks. 3. Trade information Financial Factors Of Credit Analysis ...
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