CFI CBCA Financial Analysis for Credit Study Questions

CFI CBCA Financial Analysis for Credit Study Questions Course Objectives - ANSWER -Understand the components that go into financial analysis -Calculate the key performance ratios that credit professionals use to assess a company's profitability and efficiency -Calculate the key financial ratios used to assess a company's liquidity, leverage, and coverage -Undertake a vertical analysis to determine profitability from the income statement and proportionality from the balance sheet -Undertake horizontal analysis to spot trends and analyze their meaning -Perform industry benchmarking While you might have your own ideas, do not volunteer them up to management. Instead, - ANSWER ask open-ended questions to allow them to provide you with a more thoughtful and accurate answer. By using a probing process, it will help you interpret the results of your analysis. Understanding why metrics are changing and how management intends to address them helps make more effective credit decisions. Benchmarking - ANSWER To make ratio analysis more insightful, we need to compare the company to its industry peer group. There are two ways to compare a company to others: - ANSWER -Comparing with a direct competitor -Comparing to industry benchmarks Comparing with a direct competitor - ANSWER 1.) Proprietary rating scales at your financial institution 2.) Other commercial borrowers in your firm's credit portfolio Comparing to industry benchmarks - ANSWER 3.) Third-party data providers (IBISWorld, CapitalIQ) 4.) Publicly-traded industry comparable companies Proprietary rating scales at your financial institution - ANSWER • Many financial institutions have aggregated years of historical default data within their commercial loan portfolios • Financial institutions use this information to produce an internal proprietary benchmarking scale to use for risk rating borrowers • This is the best source of comparable data as your firm has already analyzed and assigned ratio thresholds to align with a 'likelihood of default' score • Download and work with a proprietary risk rating model in CFI's Loan Pricing Course Other commercial borrowers in your firm's credit portfolio - ANSWER • Leverage the information in your own client portfolio or within the institution's overall loan book Example: You have 12 manufacturing borrowers in your loan book and one is looking for additional financing • Cross reference your client's ratios with the other 11 borrowers at their most recent year-ends to get an idea of the company's relative position • Ratio calculations using internal data sources are more likely to be consistent Third-party data providers (IBISWorld, CapitalIQ) - ANSWER • Frequently have large sample sizes from a wide variety of industries - are good comparable reference points • Used by most financial institutions to enhance the credit decision-making process • CFI's IBISWorld Fundamentals Course teaches about a third-party data provider, IBISWorld • A six-month trial of IBISWorld and a two-month trial of CapitalIQ is available for all CFI Full-Immersion students Publicly-traded industry comparable companies - ANSWER • Information from an issuer's MD&A can be found using public filing systems like EDGAR, SEDAR, and RNS • Third-party data providers do not always calculate ratios the same way • Using external data providers may require you to make adjustments before ratios become usable for your comparable analysis Efficiency & Liquidity - ANSWER Ratio Analysis Performance Ratios - ANSWER Breaking Down the Balance Sheet Efficiency ratios look at - ANSWER how efficiently a company is using its assets. To calculate these ratios, both the income statement and the balance sheet are used. Asset Turnover Ratio - ANSWER = Net Sales / Total (or net) Assets Indicates how many dollars of revenue are generated for every dollar of assets. Credit professionals tend to focus on efficiency ratios related to - ANSWER working capital; efficient cash management leads to a higher probability of a strong management team, a sustainable company, and the capacity to repays debts. Working Capital Formula - ANSWER Current Assets - Current Liabilities There is a more narrow and focused relationship among working capital accounts for credit analysts. Working Capital Funding Gap - ANSWER Cash out to cash in AP - Place an order, Supplier delivery, pay the supplier (cash out) Inventory - Supplier delivery, pay the supplier (cash out), customer order AR - Customer order, Customer payment (cash in) Liquidity Ratios - Financial Ratios - ANSWER Liquidity Liquidity ratios - ANSWER Current ratio and quick ratio Current ratio - ANSWER (CA-prepaid expenses) / CL Quick ratio - ANSWER (CA - Inventory - prepaid expenses) / CL Liquidity ratios Remove assets that do not have any - ANSWER tangible underlying cash value; the most common example is prepaid expenses. When testing liquidity ratios, include - ANSWER the current portion of any proposed new credit facilities. Leverage & Capital Structure Ratio Analysis - ANSWER Financial Ratios