Lim Chhayada 1

▪ The business credit client

▪ Qualitative analysis
▪ Quantitative analysis
▪ The 5Cs

2
▪ The assessment of credit revolves around the
analysis of broad factors regarding the environment
that the business operates in, and harder factors
about the customer’s business. As repayment is a
future event, we must also be able to forecast likely
business performance.
▪ Banking is all about the management of risk. The
bank looks at what risk is, who banks lend to, how
they package their lending and, importantly, how
they assess lending requests.
3
Sole proprietor
▪ An individual carrying on
business in their own name
▪ Enjoy full control
▪ Unlimited of liability
▪ Limit to skill set
Partnership
▪ Two or more people in
business to make profit
▪ Shared responsibility
▪ Potentially more capital than
sole proprietorship
▪ Joint and several liability
▪ Disagreements may occur
Limited company
▪ Separate legal personality
▪ May be limited by
shares/guarantee
▪ May be unlimited (very rare)
▪ Listed company shares are
traded on stock exchange
4
 Political Competitive
Developments in environment
Economic Changes in the
political environment
Changes in the market and the firm’s
in which the firm
trade cycle competitors
operates
affecting the firm
Third parties
Social and market
Factors affecting
forces
supplies and outsource Business risk Societal changes
partners that have a
affecting the firm
knock-on effect on the
firm
Shocks and Technology
External Technological
natural events
stakeholder changes in what the
Climate events,
The effect of firm does and how it
acts of God
interested parties on does it
affecting the
the firm
business
5
The Challenge:
▪ Repayment is made in the future,
for lending granted today – but the
quantifiable financial details
presented by the customer are
historic
▪ Past performance is not totally
reliable as an indicator of future
performance – the unexpected can
occur.
Why?
▪ Changes in technology can make the
product obsolete, or not as attractive
as it is now
▪ Management and/or key personnel
may change
▪ Government support could be
withdrawn
▪ The product life cycle may dictate that
the product has come to the end of its
useful life
6
 The banker must always look
at primary repayment –
collateral is just a safety net

If the customer offers good

collateral, that can be used to
repay if the customer defaults

Our primary concern is the

borrower’s ability to repay

7
Corporate Business Consumer/Personal

▪ Lending to large ▪ Lending to medium ▪ Lending to individuals,

organization business/unlisted families and small family
▪ Called prime corporate companies businesses
▪ May be funded from
financial market

8
 Qualitative analysis Quantitative analysis

Broader issues: the state of

Harder facts relating to the
the economy, the industry
customer, e.g. ratio analysis
sector, competition, etc

Both areas must be considered as part of the credit assessment process.

9
The product life cycle

Products have life cycles to work through from innovation to obsolescence – this cycle applies to
whole industries too.

development introduction growth maturity decline

Sales volume

10
Time
Understanding the business environment : top-down credit analysis
International issues
War and peace – politics – domestic economics –
exchange rates and domestic liquidity – trade and tariff
negotiations etc. – international environmental issues –
technology

Domestic issues
War and peace – politics – domestic economics –
exchange rates and domestic liquidity – trade and tariff
negotiations etc. – international environmental issues –
technology – domestic political consciousness and
political trends (conservatism v liberalism etc.)

Industry issues
The competitive environment of the company in relation to
its competitors, suppliers, buyers, potential entrants and
substitutes (the five ‘Porter’ forces) – technology product
and industry life cycles

Company issues
The capability of the company, assessed according to the
methodology; architecture, reputation, innovation
11
Understanding the environment: international / environmental issues

International/environmental issues

Wider issues Country/regional issues Industry/sectoral issues

▪ What is happening? ▪ Economic, political, ▪ Life cycle stage?

▪ How will it affect the regulatory issues in countries ▪ Technological development?
customer? that the customer trades with ▪ Competitors?
▪ What is happening in key ▪ Globalization issues?
economies?
▪ Trade/tariff sanctions?
▪ Social trends

12
Summarizing the qualitative analysis into a SWOT analysis

Strengths Weaknesses
Internal

Internal
▪ What the firm is poor at
▪ What the firm is good at
▪ Where it performs weakly
▪ Competitive advantage
compared with competition

Opportunity Threats

External
External

▪ Where could business be lost

▪ Areas where the business can ▪ Global/technological factors
take advantage that could disadvantage the
firm?
13
 The key financial statements
Balance sheet
Snapshot of what the business
owns (assets) and what the
business owes(liabilities)
Prepared historically –
looking back in time
Prepared on accrual basis
P&L account
Statement of profit (or loss)
made over a specified
accounting period – usually
one year
Prepared historically –
looking back in time
Prepared on accrual basis
Cash flow statement
Explains the source of funds
and the application of funds
Summarizes the movements of
cash in the business
Prepared historically
Prepare on a cash basis
14
 Financial analysis techniques
▪ Used to assess company performance over time (horizontal analysis) and make intercompany
comparisons (vertical analysis)
▪ Used to highlight areas for investigation – but not an absolute indicator of performance
▪ Can be presented as ratio, multiples or percentages
▪ Most source information is the financial accounts

Areas of ratio analysis

Liquidity Performance Gearing Key asset areas

Availability of funds How profitable is Relationship between Performance of stock,
to meet debts the business? Is it internal/external debtors, creditors,
growing? funding fixed assets

15
Financial analysis techniques: liquidity ratios

Working capital = Current assets – Current liabilities

Current assets A ratio in excess of 1:1 means that the firm has more current assets
Current ratio: than current liabilities. It should be able to meet debts as they fall
Current liabilities due.

Current assets - Stock

Stock is removed from this ratio as it may take time to convert
Quick ratio:
stock to debtors and then cash
Current liabilities

16
 Financial analysis techniques: performance ratios

Sales growth Gross profit margin Operating profit margin

Y2 Sales – Y1 Sales Gross profit EBIT
x 100 x 100 x 100
Y1 Sales Sales Sales
▪ How much are sales rising/falling ▪ What is the firm’s mark-up? ▪ How profitable is the firm after
paying overheads?
by? ▪ How well are overheads being
▪ Why is this happening? controlled?

Pre-tax profit percentage Interest cover Return on equity

Net profit before tax EBIT NP after tax
x 100
Sales Interest expense Equity
▪ How are costs moving compared ▪ By how many time does profit ▪ How are earnings and
with sales? exceed interest expense? invested/retained funds related?
▪ Do we need to examine trends in ▪ Relates borrowing to
individual costs? profitability

17
Financial analysis techniques: gearing ratios

Gearing ratio

Total liabilities ▪ The relationship between internal and external funding

▪ How reliant is the business on internal/external funding
Shareholders’ funds ▪ The higher the ratio, the greater the level of financial risk

Gearing leverage ratio

Total interest – bearing debt

▪ How is borrowing moving compared to tangible net worth?
Tangible net worth

18
Financial analysis techniques: allocation in key asset areas
Days receivable ▪ How long does it take debtors to pay up?
Trade debtors ▪ How does this compare to terms of trade?
x 365 days ▪ Is a bad debt ‘hiding’ in the books?
Sales
Days inventories
▪ How quickly is stock turning over?
Stock
▪ Can be split into raw materials, WIP and finished goods is
x 365 days
obsolete/unsaleable stock ‘hiding’ in the figures?
Cost of Sales
Trade creditors’ days
Trade creditors ▪ How long is the business taking to pay suppliers?
x 365 days ▪ How do debtors/creditors ratio compare?
Cost of Sales
Sales to fixed assets
Sales
▪ What sort of return is the business getting from fixed assets?
Fixed assets
Net operating cash flow ratio
Net operating cash flow ▪ Is the firm funding the operations by overdraft?
▪ Has the business the ability to pay operating liabilities from
Operating liabilities operating cash flow? 19
The 5Cs
The principle of lending
A structure approach to credit assessment, seeking to ensure that all relevant factors are taken
into consideration. Their use will reduce – but never eliminate – risk.

Person Character Character

Amount and purpose Ability Capacity
Repayment Margin Capital
Security Purpose Collateral
Expediency Amount Conditions
Remuneration Repayment Control
Services Insurance (collateral)
20
Character
▪ Considering the character of the
business and the management team
▪ The management team MUST be
respectable and trustworthy
▪ Meeting the customer – on their
premises – is vital
Why?
▪ The customer is more relaxed
▪ The banker can get a feel for how the
business works and how organized (or not) it
is
▪ It shows courtesy and concern
▪ It builds rapport
▪ It allow the banker to learn about the
business
21
 Character – what you need to know before meeting the customer

If a new customer,
why did they move
and what was their
How long have they Reputation?
previous conduct?
banked with you? Track record?

Repayment history?

Questions before the

meeting Is the amount and
timing of lodgments
as expected?
Account turnover
max/min, average Any items returned Any irregular
balance? unpaid – why? borrowing – why?

22
 Character – assessing the people and the business

Owners and /or The business

management team
▪ Influenced by character
▪ Obtain CVs of owners and/or
▪ Age managers
▪ Qualifications/experi Character assessment ▪ Risk-
ence taking/conservative
▪ Integrity/reliability ▪ Change
▪ Ability/efficiency oriented/conventional
▪ Introvert/extrovert
▪ Strategy or detail?

23
Capacity
Fundamentally looking at the capacity of the business to repay the borrowing.
Capacity will include:
▪ Management ▪ Competition

▪ Succession planning ▪ Industry

▪ Staff ▪ Cost structure

▪ Economic condition
▪ Products
▪ Seasonality
▪ Services
▪ Profitability
▪ The market
▪ Legal issues
▪ Premises
▪ Cash flow forecasts
▪ Fixed assets ▪ The business plan
▪ Technology ▪ Repayment
In smaller business we don’t expect the management team to have competency in all
of the key areas – but do they need to have expertise that they can call upon. 24
Capital Capital - amount
How much do you want/how much do you need?
‘Capital’ covers both amount
and purpose
I need $X, will the I got the figures They won’t
bank give me that wrong! finance this asset,
much? I’d better
‘disguise’ it as
something else!
Capital – purpose
All or any of these explain why the customer might not
▪ Is it legal?
ask for enough funding
▪ Is it within the credit policy?
Amount of funding requested
▪ Is it for what the applicant says it’s for? Loan to value (LtV) = x100%
▪ Is it to a restricted sector? Value of assets
LtV can increase customer commitment and level of risk
▪ Will it result in concentration risk?
to the bank
26
Collateral

Collateral will reduce risk to the bank – but no amount of collateral makes an unviable proposition a
viable one

The asset can betaken as collateral quickly,

Simplicity of title cheaply, and easily.

Attributes of a The assets will hold/increase in value over time.

Stability of value
good security A discount percentage can protect the bank
should the value fall and / or the debt increase.

If the bank has to call up the collateral, can it be

Realizability
liquidated easily?

27
Conditions
Terms and conditions are normal in business contracts – so they apply to credit contracts as well.
As repayment may come far into the future, the bank can manage its risk by agreeing certain
conditions that must be adhered to during the term.

Negotiate a repricing
Covenants
Customer needs to give
Possible additional collateral
outcomes of
covenant
breach The term is extended Information Ratio based (e.g.
(e.g. accounts, current, gearing,
aged lists, etc.) LtV, etc.

The whole facility is

renegotiated
28
29