PNADQ092
Transcript of PNADQ092
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USAID-Funded Economic Governance II Project
The Credit Analysis
Presented To: The Central Bank of Iraq
Date: 2006-March- 03
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USAID-Funded Economic Governance II Project – Bank Supervision 2
Authors
This document was prepared by:
Patrick Y.Trautmann
Senior Consultant
BearingPoint1676 International DriveMcLean, VA 22102-4828E-mail:[email protected]
This document is protected under the copyright laws of the United States and other countries: it has been prepared by BearingPoint, Inc. (“BearingPoint”) Technical Advisorsand/or contractors working directly for BearingPoint under the auspices of the U.S. Agency for International Development (“USAID”) contract number 267-C-00-04-00405-00.
This document and all accompanying pages are strictly for the use of USAID in support of their own consideration regarding the subject matter contained herein. Exceptwhere explicitly stated otherwise, the following information was prepared on the basis of data that is publicly available or was provided by USAID: it has not beenindependently verified or otherwise examined to determine its accuracy, completeness or financial feasibility (where applicable). Neither BearingPoint, USAID nor any personacting on behalf of either assumes any liabilities, expenses (including attorney’s fees and legal expenses) fines, penalties, taxes or damages (collectively “liabilities”),resulting from the use of any information contained in this document.
©2005 BearingPoint, Inc. All rights reserved.
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The Credit Analysis
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Overview
Learning Objectives.
z Review the key components of fundamental analysis of a borrower’s creditworthiness.
— Income statement.
— Balance sheet.
—
Cash Flow statement.— Financial ratios.
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Purpose of Credit Analysis
The purpose of the credit analysis is to identify the risks to which a
bank may be exposed over the life of a project financed by the bank,
and to evaluate if the transaction is structured in a way that makesthose risks acceptable by the parties involved.
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Know your client
Banks need to develop a good understanding of the clients and his
business.
z In the past banks relied primarily on their personal knowledge of the clients to grantloans and depended only on the collateral as a primary source of repayment in casethe client defaulted on his obligations.
z In the present world and economic environment such personal knowledge gainedthrough experience and proximity is not always practical or possible.
z Financial statements have evolved as a primary tool to assist lending officers inevaluating the lending risks and assess the companies performance.
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Know your client (continued)
Credit Analysts need to:
z Develop a good understanding of the borrower.
z Obtain and verify the information provided by the borrower (business plan).
z Identify the risks.
z Suggest a strategy for risk mitigation.
z Help borrower define his borrowing needs and repayment capacity.
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Financial Documents
Documents to be reviewed.
z Income statement.
z Balance sheet.
z Key financial ratios.
z Cash flow statement.
z Financial projections.
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The Income Statement
The income statement gives an important perspective of the health
of a business.
z It reports the selling activities of a company over a certain period of time.
z It shows the profit of the company
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The income statement (continued)
Borrower should provide three years of actual results, showing that:
z He has generated sufficient operating income.
z Sales growth are consistent with market share and market size assumptions.
z The operating margins are consistent over time.
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Sample income statement
Sales
(Cost of goods sold)
= Gross profit
(Operating expenses)
(Other expenses)
= Net profit before taxes
(Income taxes)
= Net profit after taxes
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The balance sheet
The balance sheet is the snapshot of the borrower’s financial
condit ion at a specific point in time.
z It presents:
— What the company has today (Assets).
— How much does the company owe today (Liabilities).
— What is the company worth today (Net worth/Equity).
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The balance sheet (continued)
The borrower should provide three years of historical balance sheets
in order for the bank:
z To generate, analyze and compare the ratios.
z To identify the trends.
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Sample balance sheet
Assets
z Current assets:
— Cash, short term investments,
— Receivables, inventory.
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Sample balance sheet (continued)
Assets
z Fixed assets:
— Furniture and fixtures.
— Buildings, land.
— Less depreciation.
z Other assets.
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Sample balance sheet (continued)
Liabilities
z Current liabilities:
— Accounts payable.
— Current portion of long term debt.
— Accrued liabilities.
— Other.
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Sample balance sheet (continued)
Liabilities
z Long term liabilities:
— Long term debts.
— Other.
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Sample balance sheet (continued)
Owner’s equity (Net worth)
z Paid up capital.
z Retained earnings.
Total assets = Total liabilities + Owner’s equity
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Financial ratios
Ratios are used to better understand trends in the borrower’s
financial condition and operations. They reflect how the balance
sheet and income statement intersect.
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Financial ratios (continued)
There are four kind of ratios:
z Liquidity.
z Efficiency.
z Profitability.
z Leverage.
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Ratio analysis
Liquidity ratios (balance sheet).
z Current ratio. A broad measure of liquidity which indicates the amount of current
assets available to repay the current liabilities. Ratio should be above 1
— Current assets/current liabilities.
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Ratio analysis (continued)
Liquidity ratios
z Quick ratio. A more severe measure of liquidity indicating the current liquid assets
available to repay the current liabilities. Only the very liquid assets are taken intoconsideration.
— Cash + marketable securities + net receivables/current liabilities.
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Ratio analysis (continued)
Efficiency ratios (Balance sheet).
z Receivables Days on Hand. It indicates the management’s ability to collect its
accounts receivable and is critical to the company’s cash flow.
— Net accounts receivable/Net sales X 360.
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Ratio analysis (continued)
Efficiency ratios.
z Payables Days on Hand. It indicates the management paying habits and the financing
provided by the suppliers. An increase may indicate short term answer to cash flowproblems.
— Accounts payable/Cost of goods sold X 360.
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Ratio analysis (continued)
Efficiency ratios
z Return on assets. This ratio measure the return on investment represented by the
assets of the company.
— Net profit after taxes/Total assets (Use net profit before taxes to eliminate theeffect of taxes).
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Ratio analysis (continued)
Efficiency ratios.
z Return on equity. This ratio measures the return on owner’s equity (Net worth).
— Net profit/Net worth.
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Ratio analysis (continued)
Profitability ratios (Income statement).
z Operating profit margin. This ratio represents the % of profit retained from each sales
dollar.
— Operating profit/net sales X 100.
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Ratio analysis (continued)
Profitability ratios.
z Net profit margin. This ratio represents the ability to generate profit from each sales
dollar.
— Net profit/Net sales X 100.
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Ratio analysis (continued)
Leverage ratios (Balance sheet).
z Debt to assets. It indicates the degree to which assets are funded by external
creditors. The lower the ratio, the greater is the ability of the company to repay loansin the event of a liquidation.
— Total liabilities/Total assets.
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Ratio analysis (continued)
Leverage ratios.
z Debt to equity. It indicates how many dollars of outside financing there are for each
dollar of owner’s equity. A high ratio indicates a high risk.
— Total liabilities/Net worth.
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Ratio analysis (continued)
Interest coverage.
z Indicates the degree to which earnings can decline without affecting the company’s
ability to meet annual interest costs.
— Net profit before tax + Interest expenses/Interest expenses.
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Ratio analysis (continued)
Debt coverage.
z Indicates the degree to which earnings can decline without affecting the company’s
ability to meet current long term debt.
— Net profit + Depreciation/Current maturities of LT debt.
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Ratio analysis (continued)
Debt service coverage.
z Measures how many Dollars of Cash Flow is available to repay each dollar of
principal and interest.
— Cash Flow from operations/Principal + Interest, or
— EBITDA/Principal + Interest.
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Cash Flow analysis
The Cash Flow statement is the report of flow of funds in and out of
the company:
z It allows the bank to determine the ability of the client to repay his debt.
z It shows the potential need for working capital financing.
z It reflects the changes in the balance sheet.
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Cash Flow analysis (continued)
Cash Flow sources and uses:
z Cash Flow from operations.
— Inflows:
– Cash from goods or services.
– Cash income from investments.
— Outflows:
– Cash payments to acquire goods or services.
– Cash payments for expenses.
– Cash payments to lenders.
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Cash Flow analysis (continued)
z Cash Flow from financing activities.
— Inflows:
– Cash proceeds from new equity.– Cash proceeds from new debt.
— Outflows:
– Cash payments of dividends.– Cash payments to creditors.
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Cash Flow analysis (continued)
z Cash Flow from investment activities.
— Cash inflows:
– Cash receipts from sale of investments.– Cash receipts from sale of assets.
— Cash outflows:
– Cash disbursements to buy investments.– Cash disbursements to acquire assets.
C ( )
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Cash Flow analysis (continued)
To prepare a Cash Flow statement the credit analyst need:
z Actual and projected Balance Sheets.
z Actual and projected Income statements.
C h Fl l i ( ti d)
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Cash Flow analysis (continued)
There are two ways to present a Cash Flow statement, the direct and
the indirect method.
z The methods differ only in the manner in which the operating C/F is presented.
z The bottom line is the same in both methods.
C h Fl l i ( ti d)
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Cash Flow analysis (continued)
Review Cash Flow documents.
z Construction steps.
z Sensitivity analysis.
z Best case/Worse case.
z Exercise.